Will the S&P end 2015 at 2015? Or perhaps 2243? Will the Fed raise interest rates? Well why not? If not now when? Is Greece going to leave the EU? What does that mean for QE in Europe? And of course, OMG what the fuck’s going to happen to oil!? In the coming forecast, I am going to predict the answers to all of these important questions and more.
Happy New Year everyone! 2014 is in the rear view, the US growth story is taking off like Cinderella at midnight! Can I get a high five for that 5%GDP growth?! Now that’s what I’m talking about. The Fed has been on point with their tightening like it’s no one’s business. They stopped QE right at the exact point the US hit its stride. Their track record is so bad that this seems almost too good to be true…
Because it is. The Fed has failed to take something into account. It’s just a small thing known as the rest of the fucking global economy. I don’t know what they are smoking at the Fed but please don’t give it to me.
Now I am all for the Fed raising interest rates. I get it. Raise interest rates and cause a temporary surge of capital into the US as emerging markets shrivel up like a sponge in the desert. The global economy collapses but the US doesn’t crash first so you escape the blame. It’s beautiful and brilliant. The US will be the last man standing and when the US does have a crisis we can blame it on Greece, China, Japan, Germany whoever, because they will crash first. Of course, that’s the screenwriter inside me creating a villain out of a group of unelected bureaucrats who decide the fate of the “free” world.
Before I go on with my predictions let me make this clear, If the Fed raises interest rates, the dollar will strengthen too much and that alone will be sufficient to collapse the global economy.
If the Fed tightens, the dollar will strengthen. Emerging markets will do very poorly as capital flows from their countries into the US. Emerging markets will shrivel up like a sponge under the desert sun and the US will enjoy a temporary flood of capital. This will help suppress the yields on long term US treasuries. Thus as the Fed raises short term interest rates, long term interest rates will continue to fall. The effect of this will be ceiling on interest rate hikes by the Federal reserve. I don’t expect the Fed to raise its rate above 1% before something goes horribly wrong in the global economy however, if my doom and gloom is just that, then I expect long term treasuries to put a cap on rate hikes at about 2%. Just looking back at the Fed 2004-2006 rate hike cycle, the yield on the 30 year treasury didn’t rise and I expect that to happen again. The only difference now is the 30 year is at 2.65% instead of 4.5% back in 2004.
My main fear for a long position in long term US treasuries at this point is for the Fed to do QE4. But even if the Fed does embark on QE4, at that point in time, fears of inflation could be so far removed that investors will merely front run the Fed and buy more bonds.
If the Fed decides to loosen, and prints more money resulting in QE4, the dollar will weaken and equity prices will rise. That much is obvious at this point. A falling dollar might force some people out of the treasuries and into other currencies. However, we must consider why the Fed would do QE4 in the first place. The most likely event that will force the Fed’s hand is falling stock prices. We are likely to see a correction of greater than 10% in the US stock market in the first half of the year. The question on most people’s minds is if in response the Fed will launch QE4. The Fed would be in a horrible position if it wanted to raise rates given such a strong correction in the market. Perhaps the best thing for it to do is try and talk up asset prices as much as possible while simultaneously raising rates. But this just shows how the tightrope the Fed has been walking for the past 6 years is rapidly shrinking.
Now I don’t want to fall to the same logic as the Fed, so let’s take a look at the rest of the world and see if we can’t predict the answers to some of their questions. Although this article is getting a bit long in the tooth and I will skip the explanations and give you my predictions… for now!
First up Europe. Europe will continue to struggle. Could 2015 be the year where the periphery finally collapses under the weight of its debt and bureaucracy?
Greece will most likely exit the EU this year. This could pave the way for QE in Europe. If there is QE in Europe, it will not be substantial or have a meaningful effect. I still don’t find this a likely option as Germany repeatedly has come out against QE, but with inflation falling to 2009 levels it may just finally happen.
On to oil. As the price falls, it forces producers to pump as much as they can to make a return. Even for expensive shale oil projects, once the well is dug in the ground, the cost of extraction is $20 per barrel. So the price can still drop as these companies and countries produce to prevent even larger losses. Where does oil bottom out? Low 40’s is my best bullshit guess.
The fall in commodity prices has been overshadowed by oil’s plunge. Of course we know the source of the fall in commodity prices is due to the slowdown in growth from China. China’s slow down will continue to hurt its major trading partners such as the BRICS and Australia and New Zealand. Bond yields in both Australia and New Zealand will continue to fall. A rate cut from the RBA is likely and thus buying short term Australian bonds could be quite profitable.
Russia. I almost left you out of this. I’ve made my views clear several times on Russia’s situation in Ukraine. I don’t think 2015 is the year Putin backs down. He’s been significantly hindered by sanctions and cheap oil and the Russian economy will be in full blown recession next year. There could be a significant buying opportunity by the end of the year given the recent rate hikes and currency depreciation, but I feel a turn around isn’t likely due to an imminent global depression on the horizon, which will almost certainly come before the US crowns a new king.
One last thing, headed into 2015, I remain bearish on US equities. Only a major correction and promise of more QE from the Fed will change my mind at this point. Cheap energy doesn’t help the US as much as it hurts it. The economy isn’t nimble enough to handle such a transfer of wealth from energy producers to energy consumers. Is 2015 finally the year where the Fed who has played a major part in the markets finally discovers how little control over the markets it really has? With the recent drop in oil price, the strengthening of the dollar and the flight to safety the answer seems to be yes.