2022 Outlook: Testing the guardrails
- A new wave of the pandemic could not only slow down global demand…
- …it could cause major convulsions in the asset markets
- US Fed would have to balance inflation risk against keeping the economic recovery intact
- China’s pandemic and credit stress management would be crucial for global market sentiments
- Emerging economies face the risk of Covid resurgence on one hand and Fed liftoff on the other hand
2022 ought to be characterised by strong consumer demand in developed markets and a substantial reopening dynamic in emerging markets, clouded a tad by US monetary policy moves. But the Omicron variant threatens to spoil that narrative. Even if turns out to have more bark than bite, i.e. very infectious but not particularly lethal, the world’s vulnerability to variants is well underscored, shedding harsh light on the danger posed by global vaccine inequity. Markets will remain on the edge with inevitable news-flow of this nature.
The inflation debate, supply versus demand; temporary versus structural, has run its course, with policy lift-off from the emergency accommodation very likely to be a major theme of 2022. The US Fed would have to balance inflation risk against keeping the economic recovery intact. Going into the new year, the former appears more pressing than the latter, but it won’t take too much for the latter to loom, driven by a variety of factors.
First risk factor is the state of the asset market, marked by historically high valuation across the spectrum. While rates, liquidity, and investor appetite are conducive for the froth to persist, the space between profit-taking and a downward spiral narrow at such lofty levels. Unlike the Chinese authorities, who appear impervious to asset price corrections, the Fed in particular faces tremendous pressure to support the markets; 2022 may bring several tests of such nature.
The second risk factor is China. The global economy and markets took notice of China’s market selloff and economic slowdown in 2021, but there was little spill-over. Further correction in China, be it from pandemic resurgence, regulatory crackdown, or power shortage, could put a major dent in global demand and investor sentiment.
Third, dealing with the fiscal cost of the pandemic. Many countries have seen their debt/GDP ratio go up by 15-30% over the past couple of years. Regardless of the level of interest rates, the time to stop adding to debt has arrived, which would require both healthy GDP growth and reduction in fiscal support. This would be a challenging act, to say the least, with a high chance of a few sovereign stumbles. These risks are likely to manifest outside of Asia, but the stress could spill over to these shores.
Coming back to the Fed’s forthcoming challenges, even if DM asset markets manage to handle the lift-off, two questions will linger. First, would inflation come down with a bit of policy normalisation, or would it require forceful, growth dampening action? Second, would emerging markets be able to handle the likely volatility in capital flows that would accompany the Fed moves?
It is important to pay close attention to such risks, but there is also a good chance that it could all work out. In the near term, the transition to an endemic-Covid could keep progressing, aided by wider vaccination and rollout of anti-viral treatments. Supply side bottlenecks, especially at the ports, could ease, even as consumer demand remains resilient. China-US, unlikely to become allies, could still find areas of détente, especially over climate change and technology. That could make for a calmer 2022, supported by the guardrails of geopolitics, economics, and finance.
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