Royce Funds Portfolio Manager and Principal Charlie Dreifus talks about the global slowdown in 2014 and its effects on interest rates in the U.S. and abroad, how data points for the U.S. economy and quantitative easing in the eurozone will play a big role in shaping the investment landscape in 2015, and how—with interest rates so low—wage inflation could have a positive impact on the markets.

Dave Gruber: Every year we know there’s going to be some surprises in the market. What surprises did you see in 2014 and what are your thoughts going into 2015?

Charlie Dreifus: The surprise to me and most others was that interest rates actually came down rather than going up, as was expected. And part of that was the global slowdown plus the fact that there was a lot of easing by other central banks around the world, which brought their interest rates down. And that had the effect of increasing the demand for our securities, particularly sovereign, the U.S. government securities, which brought those rates down.

Dave: Talk to us a little bit about your expectations for 2015 from a macro point of view.

Charlie: We’re talking in early January, and there’s a lot on the agenda this month. And the ultimate outcome of how the year will shape will be dependent on things that happen this month: data points regarding the U.S. economy and, particularly, what happens in Europe later this month regarding quantitative easing and the effect of Greece on that decision process.

Royce Funds: Factors that will influence 2015

Among the factors that will influence 2015’s market returns and the economy, in a sort of strange manner we should be rooting for wage inflation, which traditionally is something that could and has bothered the markets. But at this stage the Federal Reserve, in order to feel secure that the economy will not revert back to a down cycle, that there’s not only stability but further growth ahead, needs to see inflation higher.

I think this Fed, as most feds are, is viewing wage inflation as one of the keys to that, because it speaks to full employment, it speaks to potentially less social unrest, and many other attributes that society strives for.

So what I think will be important over the coming months is the employment numbers, but also evidence of a tightening in the labor market and higher wages. Now in terms of the market impact, traditionally this is a negative because inflation above a certain level, taken to the extreme, certainly is a negative to the market.

Right now we’re at such a low level, and interest rates are at such a low level, it’s frankly going to be viewed as a positive because it will, again, reinforce the notion of the sustainability of the economy without reverting to a recession. It will also have the impact of making consumers want to buy things because they expect prices to rise rather than decline, and they will have the means to do that.

So it’s a very self-fulfilling cycle until it gets to the point where it too has the effect of spiraling through the economy, at which point it does become a negative.

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Royce Funds: Surprises in 2014 and Expectations for 2015