With the first quarter of 2014 proving to be an eventful one, let’s begin by revisiting our core outlook for 2014 before reviewing this in light of short-term events—in particular the crisis in Ukraine—and how they are impacting our outlook in practice.
Our core outlook for 2014
Modest global economic recovery:
The global economy will continue to benefit from a modest recovery that is gaining momentum, underpinned by a longer-term recovery in the US economy.
Monetary policy set to be “looser for longer”:
Central bank policy will remain “looser for longer” and will become even more critical to markets as they manage a smooth transition from QE,¹ to incremental tapering steps, to becoming expert at providing sensitive and well-timed future guidance on monetary policy in the face of possible interest rate increases ahead.
Risk assets drive returns:
Risk assets may drive returns in 2014 against a continuing background of financial repression.
Ukraine’s impact on financial markets
Financial markets clearly believe that the central bank “put” is still very much in place, as exemplified by the relatively nonchalant reaction of financial markets to the geopolitical turmoil resulting from the crisis unfolding in Ukraine.
Even the latest and most critical stage in the crisis so far – Russia’s annexation of the Crimean peninsula – has done no more than make markets pause for breath. They remain quietly confident against a background of a global economic recovery that continues to gradually strengthen, in line with our forecast, even if the pace is slowing slightly.
In our opinion, the latest development should not have come as a significant surprise to spectators, with President Putin repeatedly expressing his conviction in the past, both privately and publicly, that the destiny of Crimea (and even Kiev) and Russia were intertwined. And, with fiction presaging reality, Tom Clancy’s posthumously published December 2013 novel, Command Authority
, describes a Russia/Ukraine conflict with Crimea ultimately incorporated into Russia.
Overall, we continue to expect that the political and economic fallout will be relatively minimal in the short term, though an escalation of this confrontation into Eastern Ukraine cannot be excluded. In the medium term, a more assertive Russia could lead to the re-emergence of cold war-like tensions, which could cause global trade to suffer and possibly trigger negative repercussions for the price of commodities. Both could impact global growth.
The re-emergence of a more belligerent Russia will certainly also remind Europeans of the raison d’etre of the European Union. A crisis on Europe’s doorstep cannot help but strengthen the resolve among European institutions – which until recently has been somewhat weaker – to work more effectively together. This message was also emphasised by the US in recent weeks, which craves at its side a strong, unified Europe that is capable of taking firm and effective action on the global political and economic stage.
Our central thesis of central bank rates being “looser for longer” is currently being tested by subtle shifts in the rhetoric of the BOE² and the Fed.³ Forward guidance is gradually being abandoned and a more bullish tone on economic growth and employment conditions is starting to signal potential rate increases in 2015. The same cannot be said of the ECB4
however, where the tone remains more dovish; both are still struggling to raise inflation expectations amid continued weak economic activity.
Meanwhile, as predicted, riskier assets have found the going tougher so far in 2014, with lower and more volatile returns from equities, while emerging market assets have suffered from continued retrenchment by foreign investors. The next quarter or two should give us more certainty as to where we are headed.