Rising East, emerging West

Expect a better 2014. World economic growth should pick up and inflation should stay benign. But the way growth plays out will depend largely on policy changes in the US and China, the world's two largest economies. Will incoming US Federal Reserve Chair Janet Yellen be able to finish unwinding the Fed's five-year-old quantitative easing (QE) program without hurting the fragile recovery? Can Premier Li Keqiang execute the boldest set of economic reforms in three decades to turn China into a more sustainable, consumer-driven economy? We think the answer is "Yes" to both questions.

All signs point to a stronger year for the world economy, with global growth expected to accelerate to 3.3 percent from this year's 2.7 percent thanks to improvements in the US and Europe. Nothing signals this better than outgoing Fed Chairman Ben Bernanke's decision to start unwinding QE in the US - this pronouncement is a vote for the growing strength of the US economy and shows how far the economy has progressed since the dark days of 2008-09. A recovering West is excellent news for world trade and for the continued outperformance of emerging markets.

The expected ending of QE by the close of 2014 would be a significant event, even if QE was never the answer to all the challenges facing the developed world, particularly the US. With policy rates hovering close to 0 percent, QE was unlikely to raise growth and encourage job creation. And it did not. It did, however, play an important role.

QE helped the Fed manage interest rate expectations. A central bank that is implementing QE is highly unlikely to hike interest rates anytime soon. As a result, long-term market interest rates remained low, and this helped some parts of the economy, particularly the housing market, to recover.

Yellen's most important action once she takes charge of the Fed should be to orchestrate a smooth unwinding of QE without causing a sharp rise in long-term interest rates. Yellen and the other Fed policy makers will need to see strong evidence that the economy is about to accelerate as it proceeds with tapering. We expect the US economy to show enough resilience for the Fed to complete tapering by the end of 2014.

With QE coming to a close, the Fed is likely to rely mostly on forward guidance to influence market rates, which may not be as effective. As a result, expect market interest rates to move higher in 2014. Inflation still remains benign, with the exception of a few emerging markets; commodity prices are stable; and labor markets, both in the US and Europe, remain substantially slack. Meanwhile, the Fed is likely to raise its benchmark policy rate only at the end of 2015.

Where does this leave Asia and the other emerging markets? The acceleration in US activity and Europe's return to growth after two years of contraction are pleasant changes for Asia, which for the past five years has been relying mostly on domestic demand and trade with other emerging markets to power the global recovery.