2015–2016 Outlook: Low for Long

Genevieve Signoret

Letter from the President

We’ve updated our Quarterly Outlook for the global economy and asset markets, which now goes through the fourth quarter of 2016. You can consult full forecast tables here and scenario assumptions here. In coming days we’ll publish the full report. Meanwhile, we leave you with this summary.

Our central scenario is called Low for Long. In it, neither the U.S. nor the euro area sinks into deflation. It is premised on the fact that a drop in measured inflation caused by a drop in the relative price of something like energy, which occupies a large weight in consumer price indices, is not deflation. It’s a change in relative prices. Low for Long does recognize that such an event can lead to deflation if it destabilizes inflation expectations, but assumes this (small) risk away. It assumes further that the European Central Bank’s (ECB’s) late action expected this month to extend its quantitative easing program include sovereign debt securities turns out not to have come too late and is well enough executed to prevent deflation. Also, that Fed rate normalization proves not to be premature, and is carried off smoothly. Finally, that the energy price drop provides only a weak boost to global consumer demand.

We forecast under Low for Long assumptions that global growth remains weak and inflation rates low. The Bank of Japan maintains its asset purchase program throughout the two-year forecast horizon. The ECB extends and maintains its own program. The Bank of England (BoE) and the Fed start normalizing rates in the second half of 2015 but do so only slowly, reaching rates above zero but abnormally low for an expansionary period for the entire two years. The Bank of Mexico raises rates in the second half of 2015 also, to 4.0%.

All this easy money keeps the bull market running by forcing investors to reach for yield.

U.S. GDP growth is 3.0% in 2015 and 2.8% in 2016. For Mexico, the two rates are 4.0% in 2015 and 3.7% in 2016. PCE core inflation in the USA reaches only 1.8% by the end of the forecast period. In Mexico, headline inflation ends 2016 at 3.8%.

Non-dollar currencies in this scenario continue to weaken or remain weak against the U.S. dollar till the Fed starts to move and communicate. After that, markets realize that they’d exaggerated the danger. They finally become believers in Fed vows not to tighten too quickly. Non-dollar currencies recover some of their value against the dollar but then stabilize at valuations considerably weaker than those of 2013. Commodities, too, recover a bit. The forecast period closes with the USD/MXN at 13.50 and Brent oil at $50/barrel. Loose money keeps the bull market running. We assign a 70% subjective probability[1] to Low for Long.

We also envision a downside risk scenario called Deflation (probability=10%), the key assumption of which is that central banks err. Other assumptions are that geopolitical tensions rise and elevate energy prices again, ruling out the boost that today we all hope and anticipate will come from their current collapse. The euro area sinks into a depression and deflationary spiral. By the end of the forecast period, the monetary union seems likely to break up. Brent oil sinks to $25/barrel. The USA and Mexico stagnate.

Finally, we imagine an upside risk scenario called Boost (probability=20%) in which the ongoing drop in energy prices provides an unexpectedly strong boost to global growth.

Previous Letters from the President

Still bullish on equity, happy with 7–10-year bonds (2015 01 08)
While we huddle, here’s my guest column on oil (2015 01 02)
Where the peso’s going and what to do (2014 12 15) 
U Turn (2014 08 12)

[1] Our approach is an adaptation of the Shell approach, as laid out by Peter Schwartz in The Art of the Long View: Planning for the Future in an Uncertain World, and Kees van der Heijden in Scenarios: The Art of Strategic Conversation.