What To Look Out For In 2015

Uwe Bott

 December 26, 2014

In our complex and interconnected world, there is an almost infinite number of risks that could have worldwide market implications. But I would focus on four major risks for 2015.


First, there is geopolitical risk and I would be most concerned about Russia. Of course, there is the obvious dimension of growing political and military tension between the West and Russia. Russia's annexation of Crimea and its invasion of eastern Ukraine in 2014 have shown the insatiable nationalistic appetite that rules the country and its leadership. In months to come, Russia will further test NATO through military maneuvers and potentially threatens to turn off gas supplies to Western Europe (which imports 30% of its gas from Russia).


Russia will also increase its state-sponsored cyber-attacks. It is assumed that state-sponsored Russian hackers recently accessed confidential information of 76 million households with accounts at JP Morgan Chase. So far, no fraud seems to have been reported, lending credibility to the assertion that this is a warning telling the U.S. and its allies: "Watch your step. We can hurt you and we will."


Russia is also an economic "threat". Western sanctions have deeply hurt the country's economy. With oil prices plummeting, the structural weaknesses of the Russian economy become all the more apparent. I would not be surprised by a Russian default in 2015.


This adverse development could embolden President Putin to distract the attention of the Russian people by increasing his expansionist, nationalist policies by another notch.


Although Vladimir Putin has effectively eliminated all political opposition, a deep economic crisis could also cause political instability in Russia. Such instability of the world's second-most armed nuclear power would be very unsettling and disruptive to financial markets.


Second, there is economic risk, mainly built around the oil markets in 2015. Prices have fallen dramatically since the summer of 2014. There are three reasons for that: (i) low global demand; (ii) growing market share of renewables; and (iii) U.S. shale exploration which will catapult the United States to become the largest oil producer in the world, surpassing Saudi Arabia in the months to come. And shale oil production will continue to grow in the United States, although at a slower clip given lower prices. Some of the more leveraged, smaller shale producers may very well go out of business. But generally, it has been assumed that growing efficiencies in shale oil production has lowered the breakeven price to $42 a barrel.


This sets the stage for further downward pressure on prices. OPEC has decided not to cut its production in order to boost prices. Saudi Arabia, in particular, might speculate that lower prices will destroy much of the shale oil industry in the United States, as low prices did to U.S. traditional oil production in 1986, when Saudi Arabia last pursued this strategy.


This may be a miscalculation on part of the Saudis, however. On the other hand, consistently low oil prices will have very negative effects on countries, which depend on oil revenue to balance their fiscal accounts, such as Venezuela, Ecuador and Russia. But it will also drive producers out of the market, whose oil production is especially costly such as Brazil with its deep-water oil exploitation. While low oil prices may please many consumers, their global macroeconomic effects may create more downside risks than upside potential.


Third, there is domestic U.S. risk. Re-jiggled majorities in the U.S. Congress may create challenges or opportunities, as the U.S. will move towards true "cohabitation" with a Democratic President and a Republican legislature. It is entirely possible that the legislative stalemate of the past few years will continue. Congress may fail to approve meaningful laws or it may approve laws that will most certainly force President Obama to unleash his veto pen.


But there is also a chance that some common ground on major economic issues may be found. Trade Promotion Authority (TPA) expired in 2007. TPA allows the President to negotiate trade deals and broadly speaking limits the power of Congress to an up or down vote. Democrats are far less willing to grant such authority to the president than Republicans due to concerns from a union-driven agenda to protect American jobs.


If Republicans majorities in the House and Senate were to grant President Obama such fast track authority, this could greatly accelerate negotiations for the Trans-Pacific Partnership (TPP) Agreement and the U.S.-EU Transatlantic Trade and Investment Partnership (T-TIP). Such trade agreements could be greatly beneficial to all parties. Progress on this front would likely be a major market mover.


However, political polarization has poisoned the well. President Obama's use of his executive powers may be a major political hurdle to Republican majorities.


Lastly, there is the Eurozone. As the late economist Ruediger Dornbusch said: "Crisis takes a much longer time coming than you think and then it happens much faster than you would have thought." As for the Eurozone, there has been permafrost ever since Greece nearly sank under its huge debt burden in 2009. Other countries followed and today there are many question marks.


While we came close to a breakup of the Eurozone on a couple of occasions, the event has obviously not materialized. The decision of Greece's Prime Minister Samaras to advance presidential elections to the second half of December from an expected date of February will give us some idea about how 2015 might shape up.


These elections are held in parliament and there are a maximum of three ballots for the governing coalition to attract at least 25 members of the opposition to vote in favor of the government's candidate, Stavros Dimas. During the first two ballots, Mr. Samaras failed to attract the necessary votes. Should he fail in the third and final ballot on December 29th, he has to call for new parliamentary electionl.


Current opinion polls show that the left-wing Syriza party is likely to win such a contest. Its leader, Alexis Tsipras, has been an outspoken critic of the government's various agreements with its creditors and he favors an exit from harsh austerity programs. At best, this could provoke a nasty fight within the European Union, at worst populists in other so-called deficit countries could feel emboldened. Coordinated opposition could then be a growing threat to the sustainability of the Eurozone.


Of course, pressures on the sustainability of the Eurozone could also arise from a host of other threats in 2015. But in paraphrasing Mr. Dornbusch, you just never know.

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