Will 2015 Be A Pivotal Year?

The year 2015 may be a pivotal point for developed economies.

Will Europe and Japan be a recovery story and look more like a regenerated US economy, or will these economies remain in a quagmire gripped by deflation, growing unemployment and a deepening recession?

Perhaps the economic policies pursued in 2008’s financial crisis, the worst in living memory and the great recession that ensued, might have delayed the inevitable: a long term deep recession.

The answer to the above question was put-off in 2014, but it may be revealed to us as the year progresses.

There are a number of factors that investors are likely to be tracking on their radar to try and gauge whether the major developed trading bloc economies will follow the US trajectory of recovery and economy growth, which even still is not entirely without missing pieces.

So what are these factors which could divert the economy either to the path of prosperity or long term stagnation?

The geopolitical situation; The Ukrainian conflict is regretfully showing no signs of abating. In response to Russia's alleged military involvement in the crisis, the engineered crash in oil prices and western sanctions imposed on Russia could be stepped up going forward.

Russia's central bank anticipates the economy will go into a deep freeze in 2015 with a contraction in output of approximately 4.5 percent. The dramatic plunge in the Rouble in the weeks running up to Christmas has forced the central bank to push up interest rates from 10.5% to 17%.

It remains to be seen whether this will help to stabilise the rouble and prevent further capital flight. If history is any thing to go by, Russian central bank intervention might all be in vain. I wouldn't be a surprise to soon hear about George Soros's billion dollar profit made in shorting the rouble. Assuming the Russian central bank has been successful in keeping the rouble propped up and halting the tide of capital outflows, it would have come at a huge cost. Such high interest rates must make servicing business debt unfavourable in the long-run. Neil Shearing of Capital Economics says history is about to repeat itself; just as after the debt default of 1998, Russia is “staring down the barrel of a deep recession”. The depth of that slump, Shearing says, will depend on what happens to the price of oil and whether the west lifts the economic sanctions that it has gradually been intensifying since last spring.

But harsher economic conditions in Russia may push the Kremlin further away from the West and adopt a more staunch position over the Ukrainian crisis. That, in turn, would cause a step-up in sanctions and make the economic crisis in Russian even more severe.

Bear in mind that Russia has an interconnected economy, particularly with the European Union.

The Total EU-Russia trade was over €326 billion in 2013 with annual EU arms exports to Russia worth an annual £250m. So if EU relations with Russia were to worsen even further in 2015, it would not only have an adverse impact on the Russian economy, as the EU economy would feel the pinch too.

Then there is another unknown factor in the equation; the sovereign debt defaults of economies heavily reliant on oil exports. Not only Russia is feeling a credit squeeze from collapsing oil prices, Nigeria and Venezuela are also experiencing collapsing oil revenues. Political instability in countries heavily dependent on oil for their revenue could be on the cards this year and that could culminate into a sovereign debt crisis too. The more interconnected the economy is to the global financial system, the greater the impact a credit default is likely to have on global finance.

The Shale industry might go from boom to bust, brought on by collapsing oil prices possibly triggering the next sub-prime. As the Bank of England points out in its recent Financial Stability Review: “As US oil and gas exploration firms account for 13% of outstanding debt in US high-yield bond markets, an increase in the perceived or realised credit risk in this sector could lead to sales by investors and potentially illiquidity in the broader high-yield market.”

But there is also an upside to collapsing oil prices. There is ample evidence to suggest that lower oil prices tend to boost global growth. The long booms of 1948-1973 and the 15-year period that preceded the great recession of 2008-09, were both built on cheap oil. The four recessions of the post-war era (1974-75, 1981-82, 1990-91 and 2008-09) have all been associated with rising oil prices. Put simply, lower oil prices puts more spending power in the hands of consumers and businesses alike. Then based on the above global growth should pick up in 2015.

But there is a caveat. Plunging oil prices could also prompt a liquidity crisis. This would affect governments, such as Russia, Venezuela and Iran, whom can only balance their books if the oil price is at $100 a barrel or more.

What happens in China might also impact which way the global economy goes. Growth will be lower in 2015, but the big question is by how much? A slow-down in China would impact the world in two ways. Firstly, those economies exporting to China their raw materials and commodities would see demand for their exports weaken. There would also be less demand for machine tools and that would weaken German exports to China.

In the US, the big question is whether rates will rise. The last time the market got wind of a rate rise it sent emerging market currencies into a tailspin. A rate rise could also trigger volatility in the equity and bond markets. If the data coming out of the US continues to be upbeat moving forwards, rate rises in the US might be a real possibility.

Will the Eurozone be a recovery story in 2015?

Europe will have another shot at it again with its massive 315 billion euro kick start program to tackle deflation, stagnation and mass unemployment.

Maybe 2015 might also be a year of woes in the peripheral sovereign bond market. What happens in Greece will be keenly watched.

2015 will be an interesting year.