Will 2014's Trends Persist in 2015?
Desjardins, Economic Studies

Authors:
François Dupuis, Vice-President and Chief Economist
and
Mathieu D'Anjou, Senior Economist

Date: February 2015

Global Economy

2014 was a tough year in many parts of the world. Most emerging countries were still grappling with relatively soft economic growth and downside pressure on their currencies. China raised investor concern several times, but, in the end, seems to be continuing to transition toward more moderate economic growth of about 7% per year. It was a more difficult year for countries like Brazil, whose central bank had to institute key rate hikes to rein in inflation. Geopolitical trouble also complicated the situation in some regions. In Eastern Europe, the crisis in Ukraine took a very worrisome turn after Russia annexed Crimea. The subsequent tensions between Russia and the West, which drove investors away, and substantial trade sanctions put the brakes on economic activity across the region. After having put itself in a very tight spot, Russia was hit hard by collapsing oil prices in the second half of the year. Plunging oil prices were also a big worry for other major crude exporters, constituting one more risk to stability in the Middle East after 2014's stunning rise of the Islamic State.

Advanced economies overseas also had a disappointing 2014. The hopes of seeing Japan's economy strengthen in response to aggressive measures from the Bank of Japan and the Abe government quickly dissipated. The consumption tax hike even pushed Japan's economy back into recession. The euro zone also had its share of disappointment, with a slowdown of Germany's economy raising fears of a third recession. The new economic slowdown, combined with the tumble of inflation, persuaded the European Central Bank to take aggressive action, dropping its key rates to their floor—even into negative territory for the deposit rate—and instituting programs to buy financial assets. It will even soon start to purchase sovereign bonds. Although the Japanese and euro zone economies are starting 2015 in a difficult position, their weak currencies and sharp drops in the cost of their oil imports could help them grow a bit faster this year.

United States

While, in general, 2014 was a difficult year for the rest of the world, the situation in North America was much better. The year had started on a sour note, when the very harsh winter prompted a contraction of the U.S. GDP in the first quarter. After that, however, activity rebounded spectacularly. The job market's performance is also very encouraging: nearly 3 million jobs have been added and the unemployment rate has dropped 1.1 % since the end of 2013. This prompted the Federal Reserve to wrap up its third quantitative easing program last fall and signal that it could start raising its key rates around mid-2015. The already good outlook for the U.S. economy improved further when oil prices collapsed. Although U.S. oil output has surged recently, the country remains a net importer of crude. The slowdown in the energy sector should therefore be more than offset by stimulus provided to the other sectors. Gasoline price's spectacular plunge is especially good for consumers whose confidence recently hit peaks that pre-date the 2007–2008 crisis. The strength of the U.S. economy compared to the rest of the world is being reflected in stock market performance. The S&P 500 wound up 2014 with a gain of over 11% while stock markets in other advanced countries had a difficult year overall. This economic divergence, combined with the contrasting monetary policy developments, also triggered a spectacular surge of the U.S. dollar. For the United States, 2014's biggest surprise came from the bond market's remarkable performance. Bond yields overlooked the good news in the U.S. and retreated under the influence of international developments, particularly the problems in the euro zone and the drop of oil prices.

Canada

Canada's economy also delivered a fairly encouraging performance in 2014. Capitalizing on a weaker dollar and more lively U.S. demand, Canadian exports have finally taken off. Canada's economy grew about 2.4% in 2014, and everything suggests excess production capacities are now nearly absorbed. However, plunging oil prices introduced extensive uncertainty for the country's growth outlook. For oil-producing provinces, the negative impacts are already becoming visible. The major question is whether, in the rest of the country, lower energy costs, a weaker loonie, and a livelier U.S. economy will have enough of a positive effect to offset the negatives. This uncertainty prompted the Bank of Canada to reduce its key interest rates by 0.25% in January and another reduction could follow at its next meeting. The drop in oil prices had a major impact on Canada's financial markets last year, magnifying the pullback by bond yields and the dollar. It had an even bigger impact on the stock market. In the middle of the year, the S&P/TSX was posting an even more robust performance than the S&P 500, but the energy sector's 20% drop in the second half of the year really hurt. Despite everything, the S&P/TSX wrapped up the year with a very acceptable 7.4% advance.

What to Look for in 2015

The divergence in performance between the U.S. economy and other major economies, as well as the correction in oil prices, will continue to significantly impact financial markets in 2015. Oil prices and bond yields continued to drop in the opening weeks of 2015, but it would be surprising to see them fall much further, as they are already nearing the lows reached in the 2007–2008 financial crisis. Investors should also watch the Federal Reserve, as markets could see many consequences if U.S. key interest rates start to go up later this year.