Remember the popular view earlier this year? That the emerging market party was over and 2014 would be all about the recovery in the West?
The reality has been somewhat different, with recovery in the West disappointingly sluggish.
This year we expect the US economy to grow by only 2.2 per cent – no more than the average since 2009. Meanwhile, the euro area has stagnated, after growing by just 0.2 per cent in the first three months of the year.
Once again it is emerging markets that are driving the growth
While 2014 is likely to be a better year for the global economy than 2013, once again it is emerging markets that are driving the growth.
Transition has been a main theme for 2014, and this still holds true for both China and the US.
China is rebalancing its economy. Meanwhile, the US is normalising its monetary policy, ending its quantitative easing (QE) programme and preparing markets for the first interest-rate hikes in 2015.
The theme of transition will continue to apply to 2015 and beyond, but next year also looks set to be one of great divergence, with monetary policy in major economies out of sync for the first time in years.
Chinese growth will slow
The old model of growth, which was dependent on investment and exports, is unlikely to drive China through the next stage of its development from a middle-income to a high-income country. Consumption will have to gain more importance in the economy compared to investment, and the services sector needs boosting relative to construction and manufacturing.
With rebalancing comes a slowdown. And China is slowing. Authorities will be keen to ensure that the economic slowdown remains controlled, especially for the labour market and income growth.
China is accepting some short-term pain in the form of lower growth for long-term gains and more sustainable growth
The official Chinese growth target for this year is 7.5 per cent. Given the weak performance in the past three months, further policy easing will be required to achieve China’s growth targets.
But if we only focus on headline growth, we could miss China’s significant structural progress. In the first half of this year, services accounted for half of China’s growth. Meanwhile, disposable household income rose to 61 per cent of GDP and should continue to trend higher.
China is accepting some short-term pain in the form of lower growth for long-term gains and more sustainable growth.
Central bank paths will differ
The highly anticipated rebound in the US economy is at least another year way. Yet, the Fed is ending its QE programme and it is preparing the market for interest rate hikes in 2015.
Clearly, the Fed expects growth, but the US economy has seen many false dawns over the past seven years, and there is still a lot of slack in the US labour market. The hike in policy rates will have to be very gradual.
The impact ECB actions have on global liquidity is very close to that of the US Federal Reserve
For the global economy and financial markets, much will depend on the actions of the European Central Bank (ECB). In a recent paper we calculated that the impact ECB actions have on global liquidity is very close to that of the US Federal Reserve. What the ECB does therefore has significant implications, and the ECB will have to do more.
Europe’s economy is suffering from inadequate demand and excess savings. The large current account surplus, now around EUR238 billion, is not a sign of strength but a symptom of the problems the euro area faces: depressed salaries and the lack of demand.
Governments in Europe are following austerity policies and they are dragging growth lower, so, once again, all efforts to kick-start the economy have been left to the ECB.
In October, the ECB will launch two asset-purchase programmes, buying asset-backed securities and covered bonds. This is effectively a QE programme. It is a step in the right direction but it is very unlikely to be enough. The ECB will have to proceed with purchases of sovereign bonds in 2015.
Would this save the eurozone economy? Probably not, but such a development would be positive for global liquidity and therefore markets.
We expect a divergence in monetary policy, with the ECB going ahead with QE and the Fed hiking policy rates
We expect a divergence in monetary policy, with the ECB going ahead with QE and the Fed hiking policy rates. There is also the additional divergence between economic performance and asset prices.
Asset prices have been rising globally, despite disappointing growth rates in the US and Europe. Low interest rates and the efforts of central banks to boost liquidity are increasingly becoming the driving forces of asset performance. If the ECB does go ahead with more QE – and the Fed is very careful with its normalisation of monetary policy – this may well continue in 2015.
Factors remain that need consideration
But policy could also have a destabilising effect on asset prices. There are two main concerns which are not currently factored in by financial markets.
First, this will be the first time in years that we might see major central banks following opposite policies. Usually when this happens volatility increases.
Second, hiking interest rates too much too soon in the US could end the fragile economic recovery in the US, with negative consequences for the rest of the world.
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