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Capital Economics reveals its eight contrarian calls
by Dylan Lobo on Jun 24, 2014 at 10:51
The consusltancy highlights the calls it believes 'significantly differ' from the consensus.
Going against the crowd
In its mid-year update Capital Economics provides examples of where its view may 'differ significantlly' from the consensus.
The consultancy draws on research provided by a team of nearly 50 economists dotted across the globe. The team has boiled these contrarian calls down to eight.
1: Upside risks to US inflation and interest rates
We have been emphasising for some time that the big risk in the US is that the Fed will raise rates earlier and further than generally expected.
The consensus is that the Fed won’t start hiking rates until June next year and that it will then tighten policy only gradually. But while our forecast that GDP will grow by 2.2% this year and 3.0% next is close to consensus, we believe there is less spare capacity, especially in the labour market, which means both wage growth and core inflation will rise more quickly.
This may prompt the Fed to start hiking in Q1 next year. By the end of 2017, US rates could be back at 4%, pulling the dollar and bond yields higher, although Treasuries might suffer just as much if the Fed appeared to be ignoring inflation risks.
2: ECB to launch full-blown QE
We have been ahead of the pack in warning of the growing risks of deflation in the eurozone and predicting further ECB policy action.
While the consensus now expects inflation to return towards the ECB’s target over the next two years, we believe it will remain very low in response to the large amount of slack in the economy.
This will hinder fiscal consolidation efforts in the peripheral countries, suggesting that current market pricing of peripheral government bonds is much too complacent. But it should also prompt the ECB to launch a full-scale quantitative easing programme, consistent with renewed weakness in the euro.
3: Weak inflation to keep UK rates low
While we do not quibble with the consensus view that the Bank of England will tighten policy from the first quarter of 2015, we still think that low inflation will persuade the MPC to raise rates more gradually than the markets expect.
Indeed, a combination of falling import prices, unchanged energy bills and recovering productivity looks set to ensure that CPI inflation falls to 1% later this year and remains well below the 2% target in 2015.
Given this, we think that Bank Rate will still only be 1% by the end of 2015. This should ensure that gilt yields rise only slowly and prompt sterling to fall back against the dollar.
5: Canadian housing heading for a major correction
The Bank of Canada is widely expected to begin raising interest rates in the second half of 2015.
However, we think that any strength in exports and business investment will be insufficient to offset the hit from a severe housing downturn.
As growth slows and the unemployment rate rises in the latter half of next year and into 2016, monetary policy will have to remain on hold and fiscal policy be loosened. Under these circumstances, we expect the Canadian dollar to depreciate further.
5: Bank of Japan not yet done
Japan’s central bank is widely expected to cease its asset purchases at the end of this year, as the economy recovers from the sales tax hike and inflation appears to be on track to hit the 2% target.
However, we expect inflation to fall short and haven’t forgotten the dire state of the public finances. Our view is that this will prompt the BoJ to extend its asset purchases into 2015 – with the announcement most likely this October.
This in turn should undermine the yen and lead to a renewed outperformance by Japanese equities.
6: No “hard landing” in China
We argued for several years that consensus expectations for China’s growth were excessively optimistic. Now, though, the consensus has swung too far in the other direction, with many believing a hard landing is imminent.
We disagree, and expect slower but steady growth over the next couple of years. This implies that the downward pressure on commodity prices will linger for a while, but the major part of the adjustment should already be behind us.
Expectations for the renminbi have also shifted recently, as the People’s Bank has succeeded in convincing investors that the currency is now close to its fair value. Our analysis of the fundamental forces leads us to a different conclusion: that further significant appreciation still lies ahead.
7: Other strong GEM calls
China is only one of 56 emerging economies that we cover – and among the rest we have several strong calls.
We have argued for some time that slower growth in the rest of the BRICs is the result of structural problems ineach country, meaning that economic weakness will be longer-lasting than many expect.
More recently, we have warned that, amid concerns about the impact of Fed policy on the EM world, some domestically-generated risks are being overlooked.
In particular, credit has been growing at an unsustainable rate in many key EMs – notably Turkey and Thailand – and for this reason risks to growth here are firmly on the downside.
But we are also more upbeat than the consensus about the prospects for a number of EMs. In particular, we expect growth in Mexico, Central Europe and much of East Asia to be faster than most anticipate over the next couple of years.
8: GEM two-year outperformance
With some EMs set to shine and others to struggle, the key for investors will be to differentiate.
However, at an aggregate level we think that much of the bad news for EM assets may now be priced in. Accordingly, while EM equities have underperformed in the past two years, we expect them to outperform over the next two.