With the traditional '"cycle" model not working and policymakers disconnected, forecasting is an inexact science, argues CTAIRA analyst Chris Tarry
In Airline Business last year, we suggested that central bankers and finance ministers were somewhat optimistic in their view that, having missed the forecast for 2015, the world's economies would be back on track by 2016.
However, immediately before February's G20 meeting in Shanghai, the IMF made a number of pertinent albeit belated observations about future economic prospects. These included a "rising stress in emerging nations" and, following gyrations in financial markets, "higher risks of a derailed recovery at a moment when the global economy is highly vulnerable to adverse shocks".
The IMF did not take the opportunity to reduce its forecast for global growth of 3.4% for 2016, but conceded that a downgrade was likely when it published new figures in April.
The new forecast may be of interest in its own right, in terms of just how much lower the figure is, but greater attention will be focused not only on what the figures for future years might be, but also on the extent to which they are considered credible and reasonable.
Models tend to work because the cells are correctly connected: their approximation to reality tends to be determined by the assumptions made generally and by the nature of the causal factors that drive them. The underlying problem – evident for some time, and widely accepted – is a lack of global demand.
There may be all sorts of fancy verbiage about economic headwinds, etc, and a tendency, particularly in Europe, to turn the money-printing presses on under the guise of "quantitative easing", combined with a move to negative interest rates to stimulate spending and some inflation. In this respect, the latest announcement from the European Central Bank did not disappoint.
However, the reality is that the traditional economic cycle was broken a long time ago and that historical cause-effect relationships – on which current policy initiatives appear to be based – have ceased to apply. Against this background, it is worthwhile recalling Einstein's definition of insanity: doing the same thing over and over again, but expecting different results.
In 2012, we suggested that, in many cases, given the breakdown of the traditional economic cycle, what we were seeing was and would continue to be a series of short-lived economic bubbles with no sustainable follow-through in terms of growth.
For the most challenged economies after the 2008/9 downturn, this has been the case. We have seen no real reason to change this view, and what we are seeing is a slowdown in the structural growth rate in China and further disappointment in some Latin American countries, most notably Brazil.
More recently, the Bank of International Settlements – often described as the bank for central bankers – appears to have questioned the collective wisdom of the policymakers, particularly in respect of negative interest rates.
The bank's concern is whether these would result in more spending by companies and consumers and, secondly, their impact on exchange rates. Lower domestic interest rates will generally result in a fall in the value of the currency. This will in turn result in higher inflation, through the cost of imports rising, but will also make exported goods and services less expensive. The outcome depends on the balance between imports and exports.
Despite the actions of policymakers, the one rather important missing component for economic growth is sufficient demand at current price levels. From a behavioural perspective, the more we are told it is getting difficult the less likely we are to spend, reinforcing the decline irrespective of whether or not money is perceived to be cheap – an outcome that provides yet another example of policymaker disconnect. Perhaps unsurprisingly, the future economic outlook for many is best described by a slightly inclined letter "L".
What then for the airline and wider aviation industry? Clearly, we can feed these into our traffic models and contemplate the impact on yields needed to hold volumes constant against a background where industry capacity is forecast to increase some 5% in 2016. Of greater importance is how the relationship between airline revenue and money value GDP will change over this year and into 2017.
Here, not only will we see a lower-than-expected rate of growth – exacerbated by prevailing low rates of inflation – but also a contraction in the relationship reflecting the combination of consumer caution (as an input) and lower fares (as an output).
Just as the rate of economic growth is not uniform, neither is that of capacity growth. The current availability of attractive airfares provides clear evidence the rules of economics apply to the airline industry as to every other business.
For a number of the financially stronger airlines, a fuller benefit from lower fuel prices will be evident as we go through this year and next with their previous hedging positions unwinding. But oil is now trading close to $40 a barrel, up 20% from February. Nobody really knows where it goes from here over the short and medium term – let alone the longer term – but the ability to absorb lower fares will continue to reduce.
This will be exacerbated by meaningful increases in non-fuel costs, evidenced by a raft of announcements of labour agreements in the USA and elsewhere and an already weaker-than-expected economic outlook where further downgrades will be the rule rather than the exception.
Although industry profits may be higher this year than last, how you do in the better times determines how you do when the going gets tougher. The tangible signs to be watched for are weaker-than-expected revenue performance on one side and worse-than-expected cost performance on the other, with an increasing divergence from current expectations as we move through 2016 and into 2017.
There is no time like the present to consider what the outcomes might be when things deteriorate, and how to respond.
Source: Airline Business