15 November 2021

2022 Economic Outlook: The Glidepath Back to Macro-Driven Markets

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  • When assessing growth in 2022, we think the numbers mean less than nailing the big themes when gauging the outlook for financial markets. That said, growth rates will remain impressive, with the International Monetary Fund (IMF) forecasting global growth of 4.9% in 2022 and 3.7% in 2023, both above the longer-term average.
  • We see 2022 as a transition year, with growth on a path back toward longer-term underlying trends. Complicating the story is the now clearly more than transitory global inflation surge, which threatens to cut off monetary and possibly fiscal policy support too early.
  • Our base case is that most of the supply/demand imbalances that are driving up inflation will be resolved in the first half of 2022. Yet even if easing supply chain disruptions eventually bring down inflation, central banks must decide whether they can wait that long to tighten policy or will need to step in to protect their price stability mandates’ credibility.
  • Covid is receding but not yet gone as a driver of the global economy in 2022, with vaccines and treatments lessening its impact and economies and borders opening back up. The most positive impacts of reopenings are likely behind us, but still provide tailwinds for growth.
  • The impact of climate change is looming over every economic outlook, with enormous spending needed to change production and consumption habits in alignment with commitments to keep global warming below 1.5°C.
2022 Economic Outlook: The Glidepath Back to Macro-Driven Markets

As we head into 2022 and envision what the global economy will look like, we must still keep an eye on the Covid-19 pandemic in the rearview mirror. Infections have started to pick up again in Europe, and winter in the Northern hemisphere is likely to bring with it another serious Covid-19 wave. Yet the potential impact on the broader economy has changed compared to a year ago with the availability of effective vaccines. We still have not achieved sufficient immunization rates to truly move on from the pandemic, and it looks likely that booster shots will be needed to achieve sustainable protection. However, the latest infection waves have come with far fewer hospitalizations and even fewer deaths than in 2020. So while the pandemic is not completely off the list of key drivers of the economic outlook for 2022, its importance has greatly receded.

The main transmission channel between the health crisis and the economy was the initial use of widespread lockdowns to stop the spread of Covid-19. That's what caused the 2020 recession and subsequent contractions around the world, such as in the eurozone at the turn of the year or in India in early 2021. Since the summer, though, the trend in government actions is moving in the direction of more openness and less containment. We have probably already seen most of the positive impact of reopenings, but further lifting of constraints on economic activity, including allowing international tourists back into the US, should still provide some additional tailwinds for growth in the near future.

Another positive feature in the evolution of the post-Covid recovery is the reconvergence of recovery trends in developed and emerging market economies. For much of 2021, the global recovery was very much a developed market affair, while the rebound in EM stalled out early. Part of that was related to the resurgence of the pandemic in many EM countries. Another reason was the absence of meaningful stimulus in China, which typically boosts commodity producers. Yet China’s economy wasn't hit as hard as those of most other countries and had fully rebounded by the summer of 2020. In a reversal of roles, in this recovery it's the US that is reverting to massive, debt-financed fiscal spending to stimulate its economy. And some of that stimulus is spilling out in the form of record trade deficits, which are boosting growth in the rest of the world. That’s why this is very much a US-driven global recovery.

Supply constraints and persistent inflation ramp up pressure on central banks

With the growing availability of vaccines and treatments, the big pandemic headlines are shifting from the immediate health impact to the severe supply chain disruptions that are driving up prices everywhere. One of the major questions for 2022 is how long the supply/demand imbalances will last. Our base case assumes that most of these issues will be resolved in the first half of next year. The causes of the disruptions are largely known and pandemic-related, such as local factory shutdowns and Covid-related shortages in labor supply. The fact that global GDP has only just returned to pre-recession levels suggests that the inflation surge is really not an aggregate demand problem. With more countries removing not only pandemic-related constraints but also certain forms of unemployment benefits, supply chain and labor supply disruptions should start to ease in the new year.

Easing supply chain disruptions should also help bring down inflation, eventually. But another key question for 2022 is whether central banks can wait that long, or if they will need to step in to protect the credibility of their price stability mandates. Central banks in the emerging markets have already been tightening policy for some time: GDP-weighted average EM policy rates have increased nearly 100 basis points since the middle of 2020. A few developed market central banks have raised rates as well, but all eyes will be on the Federal Reserve in 2022. We see the risk skewed toward earlier rate hikes than most forecasters are expecting. What could complicate the outlook is a potential change in Fed leadership in early 2022 if President Biden decides not to reappoint Jay Powell as chair. Yet irrespective of who is at the helm, the Fed will face its most severe inflation challenge since the late 1990s.  

And the Federal Reserve is not the only central bank under pressure. The ECB is also facing an early tapering decision on its €70 billion per month Pandemic Emergency Purchase Programme (PEPP), which is set to expire in March. Instead of a Fed-like glidepath to zero, the bank’s current plan seems to allow the program to simply run out and for total asset purchases to abruptly go from the current €90 billion average to just €20 billion. Worse, it will eliminate the ECB’s ability to buy assets flexibly and smooth out potential yield divergences. So, similar to the US, financial markets will have to learn to live without substantial monetary policy support.

Inflation hasn’t surged as much in Europe or Asia as in the US, but it is running above target almost everywhere – with the notable exceptions of Japan and China. That means most central banks that haven’t started to raise rates will have to deal with the same credibility challenge that the Federal Reserve and the ECB are facing right now. 

While more protracted inflation may shift monetary policy away from recovery support and toward stimulus withdrawal and policy normalization, fiscal policy should remain accommodative next year. The US just enacted another $1.2 trillion stimulus package, and more is still on the table. Funds from the EU recovery package are still being distributed, and the EU’s decision to suspend deficit rules through the end of 2022 should prevent premature fiscal tightening in Europe. Moreover, the new Japanese government is already calling for more fiscal spending to bring the economy back from the pandemic. 

When gauging growth in 2022, the numbers mean less than the trends

We still believe numerical growth forecasts remain less relevant for next year, and that getting the big themes right will matter more when gauging the outlook for financial markets. Having said that, growth rates will continue to look impressive in 2022. The International Monetary Fund (IMF) forecasts global growth of 4.9% in 2022 and 3.7% in 2023, both above the longer-term average. That’s essentially a soft landing back to the steady growth trend we saw prior to the pandemic.

We don’t disagree with that base case, but the confidence interval around that forecast is wide. More importantly, the prospect of monetary and in 2023 fiscal policy turning less stimulative suggests that risks to the outlook are skewed to the downside. It’s hard to see what could provide an upside surprise; perhaps a sharp drop in oil prices, or a sudden turn in China’s reluctance to boost its recovery. Neither of these seems very likely.  

In past outlooks, we have focused a lot on politics as a possible source of sudden changes in policy priorities. Elections in Germany and Japan in 2021 ended with fairly market-friendly outcomes. Still on the agenda in 2022 are presidential elections in Italy and France. If they follow the script and don’t change the status quo, Europe is looking at an extended period of electoral stability, which may allow leaders to undertake another push at further deepening economic integration.

The next big issue is a more comprehensive fiscal union. The 2020 Next Generation EU fund marked the first time leaders agreed to shared borrowing under the EU umbrella. Establishing a more permanent transfer of funding authority away from member states could overcome the potentially negative impact of the reinstatement of EU deficit rules and help fund climate change-related financing needs.

Another key political event in 2022 is the November midterm elections in the US. President Biden’s approval ratings have fallen sharply, and early polling suggests the Democrats will lose at least one of the two Congressional majorities they now hold. If that’s the case, US fiscal policy is likely to face a sudden stop and a potentially sharply negative growth shock in 2023. But that’s a story for next year’s outlook.     

Climate change drives the agenda

A theme that's looming over every economic outlook is the increasing impact of climate change. The damage from climate change-related weather events and environmental degradation is no longer a matter of random shocks but has become more forecastable, and can thus can be incorporated into economic modeling.

Meanwhile, the increasing financial commitments to keep global warming below 1.5° C, in alignment with the Paris Agreement, will necessitate enormous investments to change production and consumption habits. The International Energy Agency (IEA) estimates that in the energy sector alone, investment spending will have to increase from the current $2 trillion a year to $5 trillion by 2030 and remain there until 2050. That portends a lot of new business for companies operating in the sector. But it also increases funding pressures and will likely divert money away from other priorities in the coming years.    

Transitioning back to macro-driven markets

We see 2022 as a transition year, with growth on a path back toward longer-term underlying trends. What complicates the story is what is now clearly more than a transitory global inflation surge, which threatens to cut off monetary and possibly fiscal policy support too early. Much will depend on the resolution of supply-chain disruptions in the early part of 2022 to reduce inflation pressures and release some of the stunted growth. In that case, the glidepath will make for a more comfortable shift from policy-driven financial markets to a return of macro fundamentals as the driver of market returns.

For more economic and asset class insights, see our full 2022 Investment Outlook: Opportunities in a Climate of Change.


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