Markets spent most of 2014 calmly moving up, but 2015 may be a different story.
Outside of a brief surge in volatility in October, markets were complacent throughout 2014. Even with geopolitical crises popping up in Iraq and Ukraine, an accelerating US economy and low interest rates across developed economies were able to ease any concerns of investors. But nothing lasts forever.
The way events are lining up, 2015 will be the Year of Volatility. Markets will be waiting for major decisions from the world’s central banks and uncertainties in macro and commodity markets to broach. Here are 6 reasons volatility is poised to make a comeback.
1. The Federal Reserve will raise rates
The US economy is doing well, and excuses to keep rates low past the mid-part of next year are quickly disappearing. GDP for the third quarter was revised up to 3.9 percent, better than the 3.25 percent that was expected, unemployment continues its downward trend, and the first signs of wage growth are beginning to appear.
The only uncertainty left is when the Fed will raise rates.
The most hawkish members of the FOMC are pushing for a first quarter increase, while doves like Narayana Kocherlakota are doing all they can to prevent that. These dynamics throw a wrench in when the committee will agree to hike, leaving bond traders waiting with bated breath.
2. China’s growth and central bank intervention
The surprise rate cut by the People’s Bank of China might be a warning that the fundamentals of the Chinese economy are weaker than had previously been thought. Real estate prices are coming back down to earth, and the income that has pushed into the economy is as well.
Now, China’s growth rate still is topping 7 percent, but there is worry that the long-theorized Chinese slowdown may finally be materializing.
More than ever, China is the engine of growth in other parts of the world – from Australia to South America to the US – and a stall in East Asia will reverberate across the globe.
3. Can the ECB be aggressive enough to prevent more European deflation?
Central banks will be pivotal to how markets behave in 2015, and the most of the mystery surrounds Europe. The scourge of deflation is spreading across Southern Europe and even once-strong Germany’s growth has stalled.
While ECB President Mario Draghi has confidently proclaimed that he would do “whatever it takes” at least twice now, German officials will do all they can to prevent him from doing so if it involves aggressive monetary easing. Without German approval, Europe has a real chance of having a Japanese-style lost decade.
4. Oil prices
Oil prices are now in a true free fall. After OPEC decided not to cut production, it became clear that this group of oil producing countries was ready to play a war of attrition with US and Canadian shale oil producers.
Now it appears that oil prices could remain low until one side of the pricing war cannot last any longer.
Complicating matters are the rising US Dollar and the crumbling economy in Russia, which is the world’s third largest oil producer. Whether prices fall any further, or it is only worrying over prices that continues, valuations of the world’s largest petroleum companies will suffer.
5. Modi and Jokowi delivering on market reform promises
Narendra Modi won India’s March 2014 election authoritatively to become Prime Minister. Joko Widodo, known as Jokowi, rose to power as Indonesia’s President in July of 2014. Both won based on their pro-business platforms, and markets lauded their victories.
But how long will these new leaders have to implement major changes before markets grow wary? Already, India caused headlines by stalling World Trade Organization free trade negotiations – and even if headlines sensationalized the event, it started to undermine confidence in Modi’s pro-market ambitions.
6. Can Russia’s foreign policy withstand a downward spiral in the economy?
The situation in Ukraine may have settled to a simmer over the last several months, but markets’ worries over Vladimir Putin’s territorial ambitions have not relented.
The ruble fell by one-third against the US Dollar over the last year as capital outflows accelerated throughout the year. To defend the ruble, the Bank of Russia is spending billions of US Dollars per week and has raised rates to over 9 percent.
At some point, Russia will either begin to ease its policy or prices will fall so far that they will look like an attractive high-risk purchase. In the latter, however, expect a bumpy ride.
Each of these six big questions in the world economy will hang a veil of uncertainty over markets in 2015. Far from the peaceful ascent markets experienced in 2014, there will be a return to volatility in 2015. But that does not mean there is an impending crash; it just means that 2014 was a respite from what makes financial markets so complicated.
