Sunday, 28 December 2014

The Outlook for Global Growth in 2015

It's that time of year to look ahead to the prospects for global growth. I posted a similar outlook a year ago and recently followed up with an assessment of those 2014 forecasts. I should be clear about why I find this exercise useful. I assemble a global growth outlook not because I have faith in forecasts. I do it because I'm looking for a "consensus view" on the year ahead, a view that is presumably already built into market prices. The consensus view, as Howard Marks of Oaktree Capital recently reminded us, is "what 'everyone knows' [and] is usually unhelpful at best and wrong at worst". What will move markets in 2015 is not the current consensus forecast, but the ways in which actual growth diverges from that consensus.

With the foregoing caveat in mind, there are four things to know about the outlook for global growth:

  • 2015 growth forecasts have edged down over the past year;
  • 2015 growth is currently expected to be better than 2014; 
  • Most DM economies are expected to grow above trend, while most EM economies are expected to grow below trend;
  • Leading indicators suggest somewhat slower growth than forecast for most countries.

2015 Forecasts have Edged Down

Last year at this time, global growth was expected by the IMF to pick up to 3.8% in 2014 while JP Morgan economists expected a more modest acceleration to 3.3%. Instead, 2014 growth is now estimated to have remained flat at the same disappointing 3.0% pace as in 2013.

The focus of economists now is on growth forecast for the year ahead, but it is worth noting that views on 2015 growth have edged down over the past year. 

This year, forecasters tell us once again that global growth will pick up in 2015 to 3.8% (IMF October forecast), or to 3.5% (Barclays December forecast), or to 3.3% (JPMorgan December forecast). These forecasts are presented as upbeat news, but the reality is that the 2015 forecast for has faded from the 4.0% forecast published by the IMF in July 2014.

2015 growth expected to be stronger almost everywhere

As was the case last year,  growth is expected to pick up in most countries in 2015. Economies with the largest forecast growth pickup include Japan (1.4% in 2015 vs 0.2% in 2014), Mexico (3.2% vs 2.2%), Eurozone (1.6% vs 0.9%), US (3.0% vs 2.3%) and India (6.0% vs 5.3%). Modest growth improvements are also expected in Australia and Korea. In Canada, 2015 growth is expected to match the 2014 pace of 2.4%.

Growth is expected to slow in UK (2.8% vs 3.0%) and China (7.2% vs 7.4%), while Russia is expected to fall into recession (-3.3% vs +0.6%).

Once again: DM above trend, EM below trend

While global growth is expected to be a bit stronger in 2015, the divergence between DM and EM growth performance is expected to continue. EM growth is consistently higher than DM growth, but the important divergence is that DM economies are expected to grow above their trend (or potential) rate of growth, while EM economies are expected to grow below their trend rate. In the chart below, the blue bars show the 2015 growth forecast versus the OECD estimate of the trend growth rate for each economy.

In 2015, the larger DM economies are expected to grow at an above trend pace, while Australia is expected to grow at trend. In contrast, all of the major EM economies, except Mexico (0.3% above trend), are expected to grow well below trend, especially Brazil (3.0% below trend) and Russia in recession (6.5% below trend, off the chart). 

Leading indicators support most growth forecasts

In the chart above, the red bars show the latest OECD composite leading indicators (CLIs) versus trend for each of the economies. These CLIs generally support weaker 2015 growth than economists are forecasting, with a few exceptions.

In the DM economies, the leading indicators suggest that growth could surprise on the downside in US, Japan and Canada.

In the EM economies, CLIs suggest that growth could be weaker than expected in China and Mexico, but stronger than expected, although still below trend, in India, Brazil and Russia. Korea is an exception, where the CLI suggests strong above-trend growth.

Conclusions and Questions

2014 turned out to be a year in which global growth was modestly disappointing, but the real story for markets was the divergences in real GDP growth. Will the divergences of 2014 continue? If so, the US Fed and the Bank of England will likely begin to tighten monetary policy in 2015, while the ECB, BoJ and PBoC will likely maintain their current accommodative policies or ease further. In such a scenario, the US$ is likely to continue to appreciate against most of the world's currencies. An appreciating US dollar combined with below trend growth in China and other EM economies is negative for commodity prices and for commodity exporting countries and their currencies. 

The questions one should ask about 2015 forecasts are these: 

  • Can the macro divergences in the global economy be sustained without creating serious financial instability and in some countries and significant volatility in global currency and financial markets? 
  • Can the low growth, highly-indebted Eurozone economies and Japan sustain stronger growth with super-accommodative monetary policy but without major economic reforms? 
  • Can China navigate a soft landing of its over-leveraged economy?  
  • Can Canada and Australia, with overheated housing markets, continue to grow at or above trend after a sharp fall in commodity prices and as the Fed begins to raise its policy rate? 
  • Will we look back on 2015 as yet another year that started with optimistic forecasts and ended with disappointment? 

My tentative answers to these questions are: No, No, Don't Know, Unlikely, and Probably. As was the case last year, I suggest that investors should stay on their toes.

Ted Carmichael is Founding Partner of Ted Carmichael Global Macro. Previously, he held positions as Chief Canadian Economist with JP Morgan Canada and Managing Director, Global Macro Portfolio, OMERS Capital Markets. 

Monday, 22 December 2014

Global Macro Misses: Biggest Forecast Errors of 2014

Economic and market forecasting is a mug's game. But that doesn't stop economists and strategists from making forecasts. At this time of year, I use a variety of sources to assemble a consensus view of economic and market outcomes for the year ahead. The turn of the year is always peak season for marketing investment themes based on year ahead forecasts. I'll review 2015 forecasts in a forthcoming post, but first, lets take a look back at 2014. In particular, let's look at the notable global macro misses and the biggest forecast errors of the year.

Real GDP

I have mentioned in previous posts that, since the Great Financial Crisis, forecasters have tended to be over-optimistic in their real GDP forecasts. That was true again in 2014. In the twelve major economies we track, real GDP growth fell short of forecasters' expectations in seven and exceeded expectations in just two countries. The weighted average forecast error was -0.3 percentage points.

Current estimates of real GDP growth for the two largest economies, the US and Eurozone, fell short of forecasts by 0.2 pct pts. The biggest misses were for  Brazil (-1.9 pct pts), Japan (-1.3), Russia (-1.2) and Mexico (-1.2). Canada and India beat forecasts by 0.3 pct pts and China by 0.1. On balance, it was a fourth consecutive year of global growth trailing expectations.

CPI Inflation

Inflation forecasts for 2014 were also too high. Six of the twelve economies are on track for lower than forecast inflation, while inflation will be higher than expected in five countries. The weighted average forecast error was -0.8 pct pts, a significant miss highlighting the disinflationary pressures that continue to dominate across the global economy. 

The biggest downside misses on inflation were in Emerging Asian economies including India (-3.4 pct pts), Korea (-1.9) and China (-1.7). These countries were joined by big DM economies including UK (-1.3), Eurozone (-0.9) and US (-0.4). The upside misses on inflation were in countries that experienced large currency depreciations, including Russia (+4.8), Brazil (+0.6) and Mexico (+0.4).

Policy Rates

Economists' forecasts of central bank policy rates were close to the mark for DM economies, but there were some notable misses for EM economies. In the DM, the ECB and the BoJ made small policy rate cuts that were not expected a year ago. 

The misses on central bank policy rates for there emerging economies were mixed. The biggest misses were for Russia, which is literally off the charts, at +11.5 percentage points, and Brazil at +2.3 pct pts, both economies where the currencies suffered sizeable depreciations. In emerging economies where inflation surprised to the downside and currencies were firm, the central banks cut their policy rates more than expected, as in Korea -0.50 pct pts and China -0.40.

10-year Bond Yields

In 10 of the 12 economies, 10-year bond yield forecasts made one year ago were too high. The deflationary forces at work in the Eurozone and China pulled 10-year yields down almost everywhere compared with forecasts of rising yields.

In all of the DM economies we track, 10-year bond yields surprised strategists to the downside. The weighted average forecast error was -1.10 percentage points. The biggest misses were in the Eurozone (-1.57), Australia (-1.54), UK (-1.37), Canada (-1.04) and US (-0.92). The only exception to the downside misses was Russia, which again was off the chart, with an upside surprise of 5.65 pct pts.

Exchange Rates

The strength of the US dollar surprised forecasters.  To be fair, the USD was expected to strengthen against most currencies, but not by nearly as much as it did. On a weighted average basis, the 11 currencies depreciated versus the USD by about 6.5% more than forecast a year ago.

The USD was expected to strengthen because many forecasters believed the Fed would begin to tighten by the end of 2014. While the Fed has been edging toward tightening this year, it has found various reasons to delay, with tightening now not expected to begin until mid to late 2015. If everything else had been as expected, this would have tended to weaken the USD. But everything else was far from as expected. The ECB, the BoJ, and even the PBoC eased monetary policy, something no economist forecast a year ago. On top of that, oil prices collapsed and other commodity prices weakened so that commodity currencies like RUB, MXN, CAD and AUD weakened more than forecast.

The biggest FX forecast miss was, not surprisingly, the RUB, which again was off the charts, more than 40 percentage points weaker than forecast a year ago. Other big misses were for MXN (-15.2 pct pts), BRL (-11.0), CAD (-10.6) and AUD (-8.6). GBP was the only currency that depreciated less than forecast versus the USD.

Investment Implications

The investment implications of the 2014 forecast misses were substantial. First, global nominal GDP growth was about a full percentage point weaker than expected, reflecting downside forecast errors on both global real GDP growth and global inflation. This would normally be bad for equity markets, but the weaker nominal GDP and profits growth was offset by easier than expected global monetary policy. US equities performed well in this environment, as did markets where central banks provided unexpected easing. Second, the downside misses on growth and inflation and the central banks' responses resulted in a strong positive returns on government bonds, the opposite of what the majority of strategists forecast. Third, divergences in growth, inflation and central bank responses, along with the sharp declines in crude oil and other commodity prices, led to much larger currency depreciations versus the USD than forecast. For Canadian investors, this meant that investments in both US equities and US government bonds, leaving the currency exposure unhedged, were big winners.