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2014 Economic Commentary
Francisco Torralba, Ph.D., CFA 2014-02-10

I expect a modest acceleration of global economic growth in 2014. World Gross Domestic Product (GDP) might advance 3.5%-4% this year, up from 3% in 2013. This improvement will be most noticeable among advanced economies. Four factors are behind this acceleration: (1) moderate energy prices, as the shale oil and gas boom expand supply and China’s slowdown holds back demand; (2) a reduction in the pace of fiscal consolidation; (3) supportive monetary policy; and (4) waning of the deleveraging process in the private sector.

By region, the eurozone will probably consolidate its expansion, coming out of the 2012-2013 recession, but I do not expect annualized GDP gains to exceed 2%. Japan’s growth could be more volatile than the eurozone’s, but still strong overall in 2014. GDP should register a solid advance in the first quarter and lower gains thereafter, as the consumption tax is raised in April. Finally, in the U.S. I expect output to grow at 2.5%-3%, up from the 2% pace of 2013. I expect consumer spending to be the main driver of growth, as housing and equity prices reach new highs, and in spite of modest job creation.

The cyclical upswing in advanced economies will be in any case quite moderate, as it stands against a long-term context of lower growth. Slow productivity gains and stagnating populations continue to reduce the growth rate of potential GDP.

Inflation will probably remain low, allowing for a continuation of ultra-loose monetary policy in all four major currencies. There is scope for further stimulus by the European Central Bank and the Bank of Japan, while the Federal Reserve is likely to gradually reduce the pace of asset purchases. Barring any negative surprises, the Fed’s quantitative easing program will probably be terminated in 2015, whereas short-term interest rates will continue to be pegged near zero for at least six months beyond that.

The outlook for emerging market (EM) economies in 2014 is more challenging and heterogeneous. A handful of countries with large current account deficits and high external debt are vulnerable to capital outflows. Turkey tops my list of risky markets. Whenever turbulence rises in one of those markets this year, most EM’s will experience swings in exchange rates and equity prices, as negative sentiment (unfairly) engulfs most countries. The actual reduction of the Fed’s asset purchases might be less disruptive than the taper talk of mid-2013, which triggered a sell-off of EM assets. I believe that the gradual and predictable tapering will allow for a smooth adjustment of asset prices.

China is a big concern, due to its large size and the gravity of its imbalances. Bad debt, rampant speculation and the unregulated shadow financial system could precipitate a financial crisis. Alternatively, Chinese authorities might be able to reign in credit growth and engineer a gradual reduction of investment growth. I certainly hope for the second outcome. But one thing I have little doubt about is, as China deleverages one way or another, GDP growth over the next five years will be substantially lower than the consensus forecast.

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Francisco Torralba, Ph.D., CFA, is an economist with Ibbotson Associates.

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