Market strategists are formulating their thoughts on the outlook for 2015 and these are likely to include US growth, inflation and interest rate predictions.
We started this year with market consensus expectations of higher growth, higher inflation and a move towards the normalisation of interest rates. As we end 2014, it appears nearly everyone got it wrong, with no interest rate rises and modest growth.
Many developed bond markets are near, or at, their all-time lows in yields and markets are now pricing in a continuation of the overarching disinflationary pressures.
Breakeven rates – the difference between the yield on a nominal fixed-rate bond and the real yield on an inflation-linked bond – are near their lows and interest rate forwards are now pricing in US rate rises in late summer 2015.
Additionally, we have seen Japan adopt more desperate stimulus measures, China has just cut interest rates for the first time in two years and European Central Bank president Mario Draghi is eagerly trying to engineer more drastic quantitative easing, in the form of sovereign bond purchases.
This is all occurring amid a backdrop of sharp falls in oil prices and little to suggest there will be any sign of inflation. So why did so many get it so wrong?
To our minds, investors have anchored to the familiar events that are witnessed in a normal cycle, without standing back and properly examining the very real and sizeable differences in this cycle.
This brings me on to an article I read recently on the Swedish elections being called in March as the government collapses. It is my belief this is in no small way linked to the Riksbank’s decision to be one of the first major central banks to raise rates.
Robert Bergqvist, chief economist at SEB, who had previously spent nine years at the Riksbank, said: “It is a problem for the Riksbank’s credibility that it has to make these adjustments.”
So what have these two things in common?
Simply, Sweden is not alone and the potential for policy error has very worrying consequences.
US Federal Reserve members have helpfully laid out their expected path to normalisation in the “dot plot”. However, we contend it will be wrong on the potential for normalisation and that long-term rates will peak at much lower levels than in previous cycles.
It is our belief a number of confounding structural oddities remain in place that will cap out the potential for a vibrant and sustained recovery.
As labour markets strengthen and energy price falls free up consumer spending power, the Fed cannot be seen to be ignoring potential inflationary pressures.
While short-term inflation is not a problem, with oil prices down more than 30 per cent since the summer peak, any stabilisation around current levels could bring a marked boost to the sluggish economy.
Moreover, the Fed will be only too aware of the lessons of raising rates too soon, as noted in the Great Depression. It is treading a fine line and the chance of policy error is high.