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Economic trends of 2015

Economists are better at history than forecasting. This explains why financial journalists sound remarkably intelligent explaining yesterday’s stock market activity and, well, less so when predicting tomorrow’s market movements. And why I concentrate on economic and financial history.

Since 2015 is now in the history books, this is a good time to summarize a few main economic trends of the preceding year. And, bearing in mind the caution offered above, to speculate a bit about what may be coming down the road in 2016.

Inflation, unemployment, and oil prices

Historically, inflation and unemployment move in opposite directions, because a growing economy typically puts upward pressure on prices and employs more people.This pattern can be seen in the graph below of US inflation (red line) and unemployment (blue line) during 1948-2005.

US. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: All Items [CPIAUCSL], retrieved from FRED, Federal Reserve Bank of St. Louis https://research.stlouisfed.org/fred2/series/CPIAUCSL/, December 23, 2015.
US. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: All Items [CPIAUCSL]. Public domain via FRED, Federal Reserve Bank of St. Louis, December 23, 2015.

Compare this historical pattern with the experience of the past decade, presented below. Since the end of the recession (shaded gray), and particularly since 2011, both inflation and unemployment have declined.

US. Bureau of Labor Statistics, Civilian Unemployment Rate [UNRATE], retrieved from FRED, Federal Reserve Bank of St. Louis https://research.stlouisfed.org/fred2/series/UNRATE/, December 23, 2015.
US. Bureau of Labor Statistics, Civilian Unemployment Rate [UNRATE]. Public domain via FRED, Federal Reserve Bank of St. Louis December 23, 2015.

The conflicting signals given by inflation and unemployment since 2011 put the Federal Reserve (Fed) in a bit of a bind. Should short-term interest rates be kept near zero, as they had been for almost a decade, until inflation picks up, or increased slightly in response to the strengthening job market? In mid-December, the Fed raised the target for the federal funds rate from 0-0.25% to 0.25-0.5%. This is seen as the beginning of a gradual return of interest rates to pre-crisis levels, however, the pace at which the Fed raises rates will depend crucially on the path of inflation and unemployment throughout 2016. If the economy falters, don’t expect a second rate increase too soon.

Some of the decline in inflation has been due to the fall in energy prices (see the graph below). Oil prices, which were over $100 per barrel in mid-2014, fell to $35 per barrel in mid-December 2015. Low oil prices have resulted from reduced global demand, due to the ongoing worldwide economic slowdown, and increased US production as a result of the shale/fracking revolution.

Declining energy prices have provided a boon for consumers and non-energy industries in the US and have been particularly costly for the energy producing countries of the Persian Gulf, Russia, and Venezuela. They have also reduced incentives to conserve energy and investments in alternative energy technologies, and probably led to more pollution. It is hard to imagine oil prices falling much further; in the absence of robust world-wide economic growth, which is probably not imminent, or a major war in the Middle East, there is no obvious reason why they would return to the $100-level in 2016. Energy prices, then, are unlikely to boost inflation or become a drag on economic growth.

US. Energy Information Administration, Crude Oil Prices: West Texas Intermediate (WTI) - Cushing, Oklahoma [DCOILWTICO], retrieved from FRED, Federal Reserve Bank of St. Louis https://research.stlouisfed.org/fred2/series/DCOILWTICO/, December 23, 2015.
US. Energy Information Administration, Crude Oil Prices: West Texas Intermediate (WTI) – Cushing, Oklahoma [DCOILWTICO]. Public domain via FRED, Federal Reserve Bank of St. Louis, December 23, 2015.
The dollar and the euro

By initiating an increase in interest rates, the Federal Reserve stands in stark contrast to the European Central Bank (ECB). The Fed ended its quantitative easing (QE) bond-buying program in October 2014 and, as noted above, began to raise short-term interest rates in December 2015. The ECB has done the exact opposite by lowering interest rates into negative territory and beginning its own QE program in January 2015.

The consequences of these Fed and ECB policies, which appear likely to persist, are easy to forecast. The US-European interest rate spread will encourage money to flow from Europe to the US, thereby increasing the value of the dollar relative to the euro–an appreciation of the dollar and depreciation of the euro. The graph below, which shows the price of the euro vis-à-vis the dollar, demonstrates that the dollar has been appreciating since 2014, largely because economic growth has been more robust in the US than Europe. The contrasting monetary policies should accelerate that trend moving into 2016. This will likely hurt US exporters, since their products will become more expensive for Europeans, and will be a drag on US economic growth. It will, at the same time, provide some support for European economic growth.

Board of Governors of the Federal Reserve System (US), U.S. / Euro Foreign Exchange Rate [DEXUSEU], retrieved from FRED, Federal Reserve Bank of St. Louis https://research.stlouisfed.org/fred2/series/DEXUSEU/, December 23, 2015.
Board of Governors of the Federal Reserve System (US), U.S. / Euro Foreign Exchange Rate [DEXUSEU]. Public domain via FRED, Federal Reserve Bank of St. Louis December 23, 2015.
Count the votes

There are, of course, many other factors that will affect the world economy in 2016, particularly elections.

We have not yet seen the full effects of watershed legislative elections in Venezuela and an important presidential election in Argentina. These were decisive and potentially game-changing elections, which have the potential to bring sound economic policy to two important Latin American economies, where sound economic policy has been sadly absent for many years. Two 2016 elections will be crucial. The 8 November presidential election in the US will offer a choice between Hillary Clinton, representing continuity with current economic policy of the Obama Administration, and…a Republican candidate. That Republican could be a serious and thoughtful politician, who could provide a competing vision for the US. Or it could be Donald Trump.

Another important election that is on the agenda, but has not yet been scheduled, is the British referendum on exit from the European Union, also known as ‘Brexit.’ Prime Minister David Cameron has recently indicated that the referendum, which he had promised to hold by 2017, will now probably take place in mid-2016. With the PM’s Conservative Party—and even his own cabinet—divided on the issue, and the opposition in disarray, this is shaping up to be one of the more important events of 2016.

There is a Chinese curse, probably apocryphal, that you should live in interesting times. With sharply contrasting monetary policies on both sides of the Atlantic, declining unemployment and low inflation in the US, an appreciating dollar, and low energy prices which seem unlikely to rise anytime soon, 2016 is shaping up to be an interesting, and not a especially predictable, year.

Featured image credit: computer summary chart by Negativespace. Public domain via Pixabay.

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