This is the time of year when every self-respecting economist and political pundit comes up with forecasts for the year ahead.
These forecasts are always prefaced with a warning that this time around, the future is more uncertain than ever. And this time is no different – but I think us forecasters, on the threshold of 2016, mean it more than ever!
A range of divergent policies are being developed in this “post-reat-recession” in different parts of the world. Europe is facing the greatest refugee crisis since the second world war, which has turned the political landscape upside down – but the same can be said of the US, if the presidential debates are anything to go by. And the sequence of horrifying terrorist attacks, most recently in Paris and against the Russian airliner, will surely add to the fragmentation of the political arena, as new modus operandi between the West and Russia start to take shape.
And yet, quite amazingly, we all seem to expect virtually the same scenario for the year to come: appreciable growth in the US, a slight improvement in Europe, and emerging markets still struggling with lower growth rates than before.
But rather than focus on the specific forecasts, I suggest that the following five issues could have a resounding impact on 2016 and beyond:
First, the US recovery is in good shape and unemployment has dropped to just 5%. Therefore, for the first time in about ten years, the monetary policy is starting to reduce the degree of stimulus, though ever so gradually. This gradual raising of interest rates comes very late in the recovery, but has been held back by the subdued inflation picture as well as increased aversion to risk by central banks. Meanwhile in Europe, where the recovery has been slighter and spare capacity remains sizable, inflation is virtually non-existent, and with a clear mandate to generate headline inflation “below, but close to, 2%”, the ECB is pumping more funds into the economy.
So, the world’s two most important central banks are embarking on diverging policies. As a result, the euro-dollar exchange rate is widely expected to drop towards parity, if not even below that. However, at the UniCredit research department we are not so sure. The “fundamental” flows will remain substantially supportive of the euro because the Eurozone has a sizable current account surplus, while the US has a deficit. And even if more speculative intentions drive EUR/USD down because of the ECB, should we not then expect a counter-move by the Fed? Needless to say, the speed and direction of the EUR/USD exchange rate will have an impact on the strength and composition of the European recovery, as well as on the fortunes of many emerging markets now trying to get their growth back up to previous levels.
Secondly, 2016 will still be shaped by the refugee crisis, and not only in Europe, where about a million people have arrived in recent months, but also in the US. The refugees crisis has both short term and longer term implications. In the short term, the arrival of so many people in Europe will lead to fiscal expansion as people need to be housed and fed until they can be processed and integrated (or returned). The fiscal expansion triggered by the refugee crisis could be in the order of 0.3% of GDP, which will further enhance the recovery.
Longer term, potentially the refugee crisis could have positive implications as it helps reverse Europe’s demographic trend, assuming the immigrants can be integrated into the labour market. Indications from Germany suggest that this has been a success story so far. But the refugee crisis also implies significant longer term risks because the political fabric is shifting towards nationalist parties – or policies. So far, this has made particularly harrowing viewing in Central Europe, with Poland and Hungary in the front line. By contrast, German chancellor Merkel has spearheaded the open-door policy, but is facing significant domestic (and European) opposition. She has – rightly – predicted that Europe’s Schengen policy of border-free movement is at risk.
Thirdly, the UK will almost certainly go to the polls to decide its future relationship with the EU, most likely just before or after the summer break. Opinion polls suggest a too-close-to-call vote, but we expect the government’s campaign to stay will be successful. However, if we are wrong and the UK votes to leave the EU, there’s a fair chance Scotland will be holding another referendum on independence, which might then see the United Kingdom fall apart.
Fourth, in the world of emerging markets, particular attention needs to be devoted to China. We think the authorities can and will stimulate the economy sufficiently to generate around 6% annual growth for another year or two, but the challenges facing China remain daunting.
Fifth, how the juggling for influence in Syria and the rest of the Middle East pans out between the US, Europe and Russia will have important implications well beyond 2016. Russia speaks of a new “Yalta”, the post-WW2 agreement between the Soviet Union and the West to de facto carve the world into spheres of influence dominated by the major powers. The US and Europe resist this vision, but seem to struggle to come up with a roadmap of their own.
The last months of 2015 have reminded us that the world is a complicated place, but then again the recovery in the industrialised world still seems to be proceeding. The odds are that it will continue on into 2016 when emerging markets will likely stabilise as well. But these are at least five key issues that one must keep a watchful eye on, as they could easily upset the applecart.
This is the time of year when every self-respecting economist and political pundit comes up with forecasts for the year ahead.
