It is always good to start with where we came from, this time last year our five themes to look out for in 2015 were:
As it happened, not all of these themes emerged as the top issues to shape the economic and business landscape this year, while some of them are likely to remain pertinent in 2016.
We approach the start of 2016 largely in a better shape than where we were last year, with the world economy much more resilient and one step further in the route to recovery. Greece is no longer on the radar as a major threat to the stability of the Eurozone. China’s transition to a new economic structure is in progress, with understandable hiccups from time to time, but no major slip-up in the journey to create a new normal.
The Eurozone economy will continue to require an emergency fluid infusion drip from the ECB in the form of extremely loose, and what we used to refer to as ‘unconventional’, monetary policy, while waiting for the real medicine of fiscal and structural reforms to be properly administered. Despite this, however, there are genuine sighs of growth in Europe’s periphery where just a few years ago there was only despair.
So what should we watch out for in 2016?
There are three themes that may prove decisive in shaping the economic and business environment next year:
The anticipated first rise in the US Fed rate next week, after nearly seven years at the effective lower bound, and the likely scenario of further increases next year, albeit at a very gradual pace, could have more impact on markets than most analysts currently forecast.
Impact will be particularly felt in those emerging countries whose public and private sectors’ exposure to debt and foreign exchange have risen significantly over the past five years or so. Many emerging countries have seen their currencies weaken against the US dollar ever since the Taper Tantrum days of 2013. It is likely that the shift in US monetary policy will prolong this trend next year. Governments and corporates that took advantage of easy money, often in foreign currency, could be left exposed next year.
While OPEC’s pricing power has been permanently diminished thanks to the arrival of shale oil & gas, we are likely to see more determined efforts by Saudi Arabia to stabilise prices at more acceptable levels. Many of the oil exporting countries have seen their public finances bleed and their currencies plunge in the past year and a half, making it more possible that they would agree to co-operate in support of a higher oil price.
With stocks currently high, and prices going nowhere but down, it is difficult to envisage a scenario where oil prices could reach levels such as US$80 again. But a strong US economy, with a strong driving season, could see demand rise in the second half of next year. If that were to, say, coincide with a shock to supply in the form of major interruptions in the Middle East, markets could get unnerved. This is unlikely to shift the fundamental balance between supply and demand in the long run, but it could push prices back up later next year.
Higher oil prices would see inflation pick up more quickly globally, with the rise in US rates steeper than otherwise. In the UK, inflation is likely to be rising more quickly than under the BoE’s current forecasts, while the economic recovery should remain relatively robust. This should trigger a first UK rate rise next year, once EU referendum is out of the way.
It is unfortunate that we should prepare for further security scares and tragic incidents next year. The response to those and to the influx of immigrants fleeing conflicts in the Middle East and Africa may, however, inflict major harm on the world economy.
A collapse of the Schengen agreement, ending freedom of movement in Europe, and more stringent visa requirements elsewhere in the world, could see the movement of labour, ideas, and finance between countries greatly diminished. If companies find it harder to get their people to travel, less trade and FDI will follow. All these could hurt our productivity, and make the world a poorer place.
Having said all that, I couldn’t call myself an economist without making full use of my two hands, so I can’t finish this piece without a small health warning beginning with ‘on the other hand’.
It is plausible that, given the fundamental supply and demand realities, oil prices will remain low next year, making the timing and pace of interest rate rises in the UK and US less aggressive. We could also see reason prevails, and a concrete resolve to keep borders open.
Hence, probably my most valuable advice to our clients would be to use alternative possible scenarios to ‘stress test’ their plans, and see where bottom line losses or best case opportunities could reach under different plausible possibilities for next year.
Happy 2016 to us all.