|Many are calling 2022 the ‘policy paradox’. A year in which central banks and governments must try and navigate various conundrums without losing the trust of markets. How to tighten monetary policy and rein in inflation without killing off the recovery? How to cope with higher energy prices as the world transitions to a low-carbon economy? Fine-tuning policy settings to unravel these conflicting dynamics will not be easy.
The below is a summary of how our world of experts (fund managers and economists) see our world in 2022.
Inflation. It’s happening.
Despite central bank rhetoric about inflation pressures being transitory, some price rises look set to persist due to the supply chain blockages and de-globalisation, and, longer-term, due to the cost of getting to net-zero emissions (even with growth in economic activity slowing, core inflation isn’t expected to peak in the US until late 2022). However, letting inflation spiral out of control would only make it a bigger issue later on, but clamping down aggressively could hamper growth when it is already stalling.
On balance, interest rates are expected to remain lower for longer despite higher prices and central banks’ desire to taper asset purchases relatively swiftly. Ultra-low rates are needed to keep the system afloat, given debt levels are higher today than during World War Two. On the upside, a controlled inflationary environment will reduce real debt over time.
China, where to from here?
China emerged from COVID-19 stronger than Western economies and used the sharp rebound to tighten policy and initiate reform. As a result, China is slowing at a faster pace relative to the West. Given the substantial capacity to loosen, the view is China will re-stimulate once the downside risks from reform, especially in the property sector, become intolerable.
Policymakers in China appreciate that to accelerate the transition to a consumption and services-driven economy – and lift the quality of economic growth – requires a vibrant private/ technology sector. It also requires household spending to grow at a faster pace than incomes. China’s extraordinarily high gross savings rate, at nearly 45% of disposable income and almost double that of the Western world, needs to be run down. The broad goal of policymakers will be to incentivise consumption today rather than saving for the future via improving the social safety net through affordable housing, education and healthcare. Recent policies around anti-competitive behaviour and data security are relatively rational and consistent with policies elsewhere in the world. Nonetheless, the country’s policy stance could weigh on global growth in 2022, and consensus expectations may be revised lower.
Populism is here to stay
The end of Donald Trump’s presidency is not the end of political populism or its causes in the US or more broadly. This likely means continued political and geopolitical volatility, but perhaps more importantly, it also makes additional fiscal stimulus more likely, as governments pursue borrow-and-spend policies seeking to address the causes of populist discontent. The efficiency and effectiveness of these policies will likely be key in assessing the likelihood of avoiding secular stagnation.
What it all means for equities
There are still more positives than negatives for equities.
Looking at the risks first. Covid remains a negative, as does tensions with China. The economic recovery will slow, and that means weaker profit growth. And then there’s the short-term spike in inflation, which could become a long-term spike.
The positives are that vaccines are helping. Monetary and fiscal policy remains ultra-easy and low rates make equities relatively attractive. There’s still plenty of government stimulus coming, and earnings expectations are still being revised up. In the United States, things are a bit calmer under President Biden, and that’s a positive for markets.
Because interest rates are so low, bank deposit rates are also very low. Investors make the comparison – very low bank deposit rates or five per cent fully franked return on shares. That differential will remain for some time because when interest rates do start to rise, it should be a gradual process. Nonetheless, the expectation is there will be more volatility and more constrained returns in equity markets over the next year.
Risks to the outlook
The main risk remains Covid and how it plays out. Hospitalisation rates will obviously be very important here. If hospital systems get strained, that can lead to a collapse in the economy.
There is a risk that inflation is less transient than expected, and central banks will need to raise interest rates faster than anticipated. That would lead to a big rise in bond yields and a repricing of assets that are sensitive to those yields. That includes real assets like property and infrastructure.
In terms of global growth rates, what happens in China is extremely important. We know the Chinese economy is slowing down. Where it normally would be growing at five to six per cent, it might be closer to three or four per cent. That means that over the next few years, there will be lower growth in demand for Australian commodities.
There’s also political risk globally. There are US midterm elections next year, and the incumbent party often loses seats in the Senate, which means the Democrats may not end up with a majority. That’s why the Democrats are trying to push through their stimulus packages this year. There’s also an election in Australia, but that is unlikely to be a major driver of financial markets.
Geopolitics is also a big risk- including the relationship between the US and China and tensions between Australia and China (recently been demonstrated by moves to diplomatically boycott the Beijing Winter Olympics).