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2015 is shaping up as a turbulent year in investment markets mostly because the global economic outlook is subject to a greater than usual set of uncertainties and risks. We see the year starting on a weak, volatile note for risk assets. The best of economic growth among developed economies is still likely to reside with the United States but headwinds are showing signs of developing that may cap US economic growth in 2015. The Federal Reserve will almost certainly start to lift its funds rate (currently close to zero) either in Q1 or Q2 2015. The US dollar also looks set to strengthen further, especially if as seems likely, the European Central Bank and the Bank of Japan expand their balance sheets (adopt or extend QE) as seems likely. Also, sharply falling oil prices present a two-edged sword for US growth prospects, cutting investment and jobs in the previously booming US shale oil industry, but also providing the equivalent of a hefty tax cut to US consumers and some businesses. All told, the US economy still looks set to perform well in 2015, but not as well as in the nine months extending from the end of Q1 2014 through to the end of 2014.

Most other major developed economies are finishing 2014 on a sour note. There are exceptions, such as the fast growing UK economy and even within the euro-region Ireland and Spain, but they are relatively few. In the euro-zone as a whole growth is sliding (only 0.8% y-o-y in Q3 2014) and low inflation (0.3% y-o-y) is threatening to turn to deflation which if it occurs would make it even more difficult for Europe to deal with its high sovereign debt problem. Political pressures are also threatening with euro-sceptics likely to gain control in the snap Greek election raising the issue of countries exiting the euro. In 2015 Europe may split between those countries where the pain of fiscal austerity is starting to turn to gain, such as Ireland, Portugal and Spain and those countries where political support for giving up on austerity is growing rapidly, including some large economies such as France. Adding to a complicated euro-brew, there is a strong case for substantially more infrastructure spending in European economies that can afford it, such as Germany, but where there is resistance.

On monetary policy and the role it may be able to play in assisting growth, Europe is at war with itself. ECB President Draghi is adamant that deflation must be avoided at all costs and that the ECB should expand its balance sheet aggressively. In the press conference after the December ECB policy meeting, President Draghi as good as committed to a more aggressive policy stance in Q1 2015. The German Bundesbank, however, is strongly opposed to Draghi’s plan. On balance we see Draghi bulldozing through the Bundesbank’s objections, but if he does not, European growth prospects will sour further and the sovereign debt crisis will probably flare from time-to-time. ECB policy meetings through Q1 2015 will be potential flash points for financial market sentiment potentially adding to volatility. One saving grace for Europe is that low oil prices will help to boost growth later in 2015, but the issue is from what level through the first half of the year.

In Australia, falling export commodity prices are likely to lead to further falls in national income through the first half of 2015. At this stage, it is highly unlikely that a white knight will appear for iron ore and coal prices in the form of materially stronger growth and demand from China. Indeed, China’s economic growth rate looks likely to consolidate around a decade low 7.0% y-o-y and also with the mix of contributions to growth changing more towards services and less from industrial output. Supply of industrial commodities from Australia, however, is burgeoning on much enhanced capacity and may contribute to keeping commodity prices lower for longer. Quite likely the dent to the earnings of Australian miners from falling commodity prices will be part offset by a falling Australian dollar. It is possible that the Australian dollar could fall a long way in the first half of 2015, particularly against the US dollar. We would not rule out a potential spike down in the Australian dollar below $US0.70.

Apart from export volumes, one strong part of the Australian economy through 2014 has been housing activity, especially investment housing activity. We see housing activity topping out through the first half of 2015 and there is some risk of a general retreat in house prices. Housing investors are facing a number of negative factors in the near term. Rental vacancies are rising and yields are falling. Home lending institutions are under pressure to be less accommodating to the demands of investors in the wake of recently announced APRA guidelines and the recommendations of the Murray Inquiry. Foreign investors now face more stringent application of existing Foreign Investment Review Board rules relating to residential purchases, a new small new application fee and most importantly a falling Australian dollar.

We expect the Reserve Bank to respond to the weaker turn in the Australian economy by cutting the cash rate, probably in two quick 25bp steps to 2.00% and probably before May when the Government brings down its next Budget. At this stage, the focus of the 2015-16 Budget is still likely to be on reducing the budget deficit.

It is worth keeping in mind that the second half of 2015 will probably be much better than the first half. The lower Australian dollar, any cash rate cuts in the first half and very low energy prices will all help to boost Australian growth down the track. Low oil prices will also materially boost global economic growth, especially in countries representing more than two thirds of Australia’s export trade – China, Japan, South Korea, India and Indonesia. Growth prospects for India and Indonesia look particularly promising in 2015 where the benefit of lower energy prices will add to benefits from promising changes to economic policies after positive changes to government in both countries in 2014.

This is the last Laminar economic note for 2014 while the author takes a brief break. The next economic note will be published on Monday 5th January 2015. Wishing all readers a safe and merry Christmas, and a prosperous New Year.