JOHANNESBURG – The divergence in Central Bank policies is expected to be a key investment theme during 2015 and to impact the performance of asset classes.
Speaking to Moneyweb on a recent visit to South Africa, Dr. Jean Boivin, former deputy governor of the Bank of Canada and currently managing director and deputy chief investment strategist of the BlackRock Investment Institute, highlighted a number of global themes that could impact investment portfolios this year.
1. Divergence in Central Bank policies
Boivin said Central Banks have implemented diverging policies in the past and the current situation is not necessarily an “earthshattering moment”.
However, it is not something that was envisioned a couple of years ago. The expectation was rather that Central Banks would be normalising their policies after the financial crisis and that this would happen in the same direction, albeit at varying speeds.
But instead, the US Federal Reserve (Fed) will likely start to raise interest rates during 2015, while other key Central Banks – in particular the European Central Bank (ECB) and the Bank of Japan – are moving in an opposite direction, Boivin said.
The ECB announced a large-scale quantitative easing program to stimulate the Eurozone’s economy in January while the Bank of Japan already raised the stakes with its stimulus program in October.
Boivin said the divergence in policies around the world is expected to have a significant impact on asset classes.
2. The lower oil price
Boivin said overall the lower oil price is a positive shock for the global economy.
For consumers, it relaxes their budget constraints in a visible way (when they fill up their fuel tanks).
Boivin said in the US consumer confidence is rising – in part on the back of the low oil price. The impact is also evident in more discretionary types of spending.
From an investment perspective, this could support some firms who benefit from consumer discretionary spending.
But while the benefits of a lower oil price are widespread, the pain is concentrated. One example is the US energy sector, which will experience a significant reduction in capital expenditure over the next year.
Whether the lower oil price will support individual countries, will depend on their status as net exporters or importers of oil and on how important energy is in the average consumer-spending basket.
Boivin said a country like India (and to a lesser extent South Africa) would benefit on both fronts.
India tends to import oil and its consumption basket is heavily tilted towards food and energy. In a lower oil price environment, the country would spend less on oil imports, which supports its balances while consumers also see relief in terms of spending. It also means that pressure on headline inflation is reduced significantly, he said.
“I think that creates an environment where Central Banks have more room to manoeuvre,” he said.
The Reserve Bank of India has cut rates recently while it had to engineer a hiking cycle in order to prevent capital outflows not too long ago.
Boivin said structural reform and lower oil prices have removed some of the additional pressures, providing the bank enough space to cut rates.
“I think [this] shows the benefit that a country like India is getting and the same I think is true for South Africa.”
It doesn’t necessarily mean the South African Reserve Bank will cut rates, but it won’t have to be hiking as quickly or as intensely as it would have had to otherwise, he said.
3. Interest rate hikes in the US
Boivin said the Fed will likely start to hike interest rates in June this year.
The US recovery is well entrenched and has (to some extent) even surprised on the upside.
Ultimately it is not the timing of the first hike that matters but the path of normalisation that follows thereafter, he said.
He expects the path to normalisation to be very gradual and that interest rates will still be low by historical standards by the time the hiking cycle ends.
But what about emerging economies like South Africa?
When the Fed initially announced in 2013 that it would taper its quantitative easing program local shares took a beating and the rand weakened significantly.
Boivin said when interest rates are rising in the US and the dollar is strengthening it typically translates into a tightening of financial conditions across emerging economies.
While it could result in more pressure on these economies and risks can’t be ignored, a “taper tantrum scenario” does not necessarily have to reproduce itself.
Moreover, emerging economies are better prepared now than they were in 2013 when the taper talks started, he said.
A lot will depend on the gap between what the market has priced in and what the Fed has in mind (in terms of the normalisation path).