Europe—Economically Better, But Politically Worse
Also aided by lower energy prices, the European economies show some new signs of life while the politics get more dismal. A modest form of QE combined with some even more modest elements of financial reform garner interest from investors in some segments of their markets. Without real reform, though, or a major decline in the Euro ultimately approaching parity with the dollar, it is hard to see the Eurozone maintaining a single currency. Not an issue for 2015 although the noises will be there increasing volatility in the markets.
Japan—Abenomics Continue with the Yen Weakening Further
Lower energy prices combined with a freer hand for Abe with cooperation from Kuroda push the Japanese market up and the Yen down with continued volatility. No one is quite clear how this experiment will end, but it will likely continue at least until the upper house elections in 2016. The lower Yen does have a positive impact on Japan’s export picture particularly relative to Europe (Germany).
China—Growth Disappoints, Currency Stays Strong, and the Economic Transition Accelerates
Estimates of growth for 2015 prove to be too high with the real number approaching 5%. Lower energy prices help China’s trade balances and the general economy, giving the leaders some room to continue the transition from a labor-cost-driven export economy to an internal economy taking advantage of a huge home market while the country comes up the technology curve. China’s leaders are somewhat accepting of the lower growth rate as they push toward reform and expand the infrastructure spending, particular on transportation systems, roads, rails, ports, and airports. Two years ago, China filed more patents in each of the categories—invention, utility, trademark and design—than the perennial leaders, the US and Japan. 2015 may be the year when patents issued exceed the leaders. In addition, China takes advantage of the geopolitical and global economic turmoil to expand its influence in the Asian sphere and beyond, including moving further toward making the Yuan a reserve currency. Odds are the currency holds its own with the dollar in contrast to almost every other currency.
India—Breathing Room for Reform and India Joins the Currency Wars
Lower energy prices provide some breathing room for Narendra Modi to continue down a reform path without as much interference from other parties. The impact of energy on overall inflation, combined with weak economic results, provide room for lower rates and, to some extent, India’s participation in the currency wars. With the simple prospect of lower rates India’s markets continue to do well. A less belligerent China makes nice with India. India’s relationships with Pakistan as well as difficulties with the internal Hindu/Muslim relationships represent the few risks facing the Modi administration. Worth watching how this aspect develops.
Russia—The Financial Situation Produces a Different Path Leading Toward Regime Change
Lower oil prices continue to have a major financial impact on Russia, likely leading to a financial accident when it becomes apparent Russia’s reserves are not adequate to meet all its needs. Putin continues to take a belligerent stance toward the west and supports, overtly and covertly, continued action in the Ukraine. While Putin has consolidated power, one could make the argument that his support could erode with the general populace as shortages continue and a falling Ruble affects prices. Putin could take some unusual steps geopolitically to try and influence oil prices. At some point the financial elite and others who do not believe the country (and themselves) benefit from an anti-west view attempt to exert some influence over the current path. Ultimately, this path could lead to regime change—or a change in path. I would expect the former. Watch for indications of internal strife or a change in direction from Putin. First steps would likely be purges of those not fully on Putin’s team. Russia has an educated population and the ingredients for being an important economic player on the world stage. The current path will not get them there and will add to geopolitical volatility as long as it continues. Trading in Russian securities and the currency remains a professional’s game, but volatility makes that difficult as well.
Iran—A Settlement Sooner than the Deadline. Oil Prices Make a Difference
Sanctions and lower oil prices may work to the benefit of a settlement of the Nuclear issue with Iran before the 7-month deadline is reached. The settlement could include other elements, which benefit Iran and reduce conflict in the Middle East. Israel protests.
Oil—Prices Stay Low with Generally Positive, But Volatile Effects
We have discussed oil in every one of the paragraphs above. My belief is that oil prices will stay lower longer than many expect. In the near term, it would take a major geopolitical disruption involving the Middle East to push prices up significantly. OPEC (really Saudi Arabia and to some extent Kuwait) may be thinking strategically about the benefits of lower oil prices. It does reduce new exploration and hydro-fracturing until technology pushes down the cost curves. On the margin it can negatively affect the pace of alternative energy development. With exceptions of some of the oil producing nations it provides an overall economic lift to growth, which could put a floor under prices as demand increases sooner than otherwise might occur. For more background on this, see “OPEC and the Logic of Low Oil Prices.”
In the near term, it has a marginal impact on supply. If a well has been drilled or is partially drilled, the marginal cost of production likely leads to continued pumping. I think OPEC may be underestimating the pace of technological developments in the oil patch. If anything, companies may seek to increase their R&D to push down the cost curves. The noise from the oil companies is partly real and partly strategic as well. There is a strong belief, broadly shared, that energy independence for the US is an important objective. The noise about loss of jobs, the lack of further E&P development, the importance of energy industry capex to growth (now about 10% of total capex in the US, up from 3% in the ‘90’s), and some financial accidents will increase support for the industry and talk of why the oil price needs to be higher. In a strange way it may increase support for alternative energy development as well. If prices stay low there will be a temptation to raise gasoline taxes with some low-income credit offset under the guise of supporting the Highway Trust Fund and other transportation-related infrastructure investments.
We have discussed the changing beneficiaries of this energy-cost paradigm in some recent pieces on the Altegris Blog. I would add to that the auto industry, as, on the margin, miles per gallon becomes less of a factor in purchase decisions. It doesn’t take much of a shift to higher margin vehicles to have a major impact on autos’ bottom line.