Why the 2015 Rate Expectations are Questionable

Why the 2015 Rate Expectations are Questionable

By: Darryl Frankfort | Where To Trade | On:15-10-2014 13:21
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Key Highlights

  • World GDP growth revised down to 3.4 for 2014; 2015 forecast lowers
  • Tax rate hike in Japan will slow down growth
  • US exports to hurt form stronger dollar
  • Rate hikes in the US tied to global recovery

The major economies have been in the untested waters of long periods of ultra-low interest since the 200- 2009 crash. The USD dollar had been the major looser in this situation getting weaker relative to the other major currencies. We have been anticipating a hike in rates since tapering of the Quantitative easing program. Last quarter the US economy showed unprecedented growth that saw the USD surge back to near its pre-crisis levels.  Markets are itching to push it up further especially against the weak Euro but the fundamentals are painting a less rosy picture for the bulls.

The sluggishness in the Euro zone coupled with the corporate tax rate hike in Japan is threatening to keep the global economy at its present state. The slowdown in china’s growth rate has seen the global demand for commodities deteriorate and with it the economies that are net commodities exporters. The down turn of the German manufacturing muscle and geo-political tensions have seen the markets plunged into a risk averse  trading conditions in the meantime.

Under these conditions, the IMF world economic Outlook report was released; the world’s annualized GDP for October is projected to come at a 3.4% growth rate for 2014. This represents a 0.4% fall from September’s projection. The forecast for 2015 GDP growth is now 3.8% a fall from 4.0% the previous month’s forecast. These lower figures represent the IMF’s view of the effects that the lower than anticipated economic activity in 2014 Q1 and Q2 will have on the global economy.

The IMF report anticipated that a rate hike will occur somewhere in 2015 Q1 in the UK and in Q2, 2015 in the US. With the rate hike in the US the rest of the major economies are expected to slowly follow the US relative to their historically normal interest rate levels. The Euro zone however is projected to keep low interest rate conditions through ought that period. This report broadly matches the market expectations that the rate hike will be in 2015.

Where To Trade - rate expectation

A closer examination of the economy of the world however begs us to reconsider the assumptions that the market is making. The problem with assuming that an interest rate hike is imminent in 2015 is twofold:

First the US fed has already indicated that a rate hike in the US will be tied to the economic recovery of the world. Having a higher interest rate while the rest of the world is experiencing a slowdown will hurt net capital inflows to the US thus the FED has to consider how the other major trade partners are doing and the likely hood that they are also capable of rising their rates as well.

Secondly; we must remember that the projection for the world GDP has now been lowered the world economy is expected to perform worse in 2015 not better there the lower  global economic activity will be felt in the US. Another major factor to consider is that Europe the Largest trading bloc in the world is about to slip into a technical recession. The Euro zone is a top trade partner to over 80 countries, if it slides back to a recession the effects will be felt globally.

 

Tentative exchange rates expectations for 2015

Under the above condition, we anticipate the USD ascent to be slow but sure. Any rate hike in the US will be limited and thus the support of reversed carry trades will be limited.

Since the Stronger USD will slow down growth as exports become more expensive, the FED will have more room to maneuver before the economy overheats. This means that it can wait it out more before adjusting the monetary policy.

Under these conditions we anticipate that the dollar index will have a bias to the bullish side but mostly stay in range bound conditions until a tightening in the monetary policy in the US. We expect the Euro in its pairs to keep sliding lower for the coming quarters.

 

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