It’s been a grueling 2021. Bereavement, illness, and economic hardship due to lockdowns have been the experience of all too many. However, the economic data show a vigorous rebound from the first year of the pandemic, with trade and employment growing rapidly. Those economic trends are set to continue in 2022, albeit at a more moderate rate. However, progress has been bought at the cost of what is arguably the biggest inflation threat since the 1970s and steering against that threat while avoiding a crash in markets that are still trading at historically high multiples will take some doing. Here are some of the big trends to watch as we enter 2022.
1. The Global Monetary Tightening Cycle
The next year will be dominated by rising interest rates. In truth, rising interest rates already arrived in style in 2021 in many parts of the world, but the Federal Reserve, guardian of the world’s reserve currency, has now made the process truly global.
The first rates to rise will be longer-term ones, as the Fed winds down within the short space of three months a quantitative easing program that is still running at $120 billion a month. It’s expected to raise the target range for Fed funds by as much as 75 basis points between March and the end of the year.
Whether it tightens by more or less will depend on the path of inflation in that period. Base effects and – more importantly – a likely slowdown in the economy as the excess savings of 2020 are finally spent, suggest that inflation should weaken in the course of the year: the Fed itself sees core personal consumer expenditures rising only 2.6% next year, after a 5.3% increase this year. The other major factor will be how much pressure the Fed comes under from Congress as the mid-term elections near in November.
Either way, as long as the Fed remains in tightening mode, the pressure on other central banks – with the exceptions of Switzerland, Japan, and possibly China – to keep tightening will remain.
2. Covid: Year 3 And Counting…
The course of the pandemic will arguably be the greatest single influence on the thinking of the Fed and many other central banks. As of the time of writing, the Omicron variant is on a tear through Europe and is now present in 43 of the U.S.’s 50 states.
Not enough is known about Omicron to make any forecast with confidence. Initial studies suggest that it is less likely to lead to serious illness than the hitherto-dominant Delta strain, but that it also evades the immune defenses generated by a two-shot vaccination, allowing it to spread faster.
Lower virulence will not be enough to avoid fresh lockdowns if the number of infections continues to double every three days, as it is doing in parts of the world at present.
Encouragingly, it seems clear that booster shots of the Moderna (NASDAQ:MRNA) and Pfizer/BioNTech vaccines will buy time for new drugs specially tailored to Omicron to be developed. Equally, the supply of vaccines and, increasingly, antiviral drugs continue to expand, especially through the WHO’s Covax program.
That should reduce the disparity in access to vaccines that has given the virus freedom to thrive and mutate at will in the world’s poorer countries. The current COVAX forecast projects it will have made 2.39 billion doses available by March, as well as options for a total of over 6.5 billion doses by 2023.
3. China’s Trifecta: Omicron, Evergrande and Taiwan
Omicron may seem less dangerous to human life than all dominant Covid-19 strains before it, but it still poses a serious threat to financial markets because of the reaction function of the world’s two largest economies.
In the U.S., vaccine hesitancy means that the risk of rapid transmission is especially high. That could lead to waves of high absenteeism, making existing labor shortages worse. However, the real supply-side risk is in China, because of its tendency to lock down hard and wide in response to any sign of Covid. Given the reported low efficacy of the two main Chinese vaccines against Omicron, the risk is of renewed closures of important Chinese manufacturing and logistics hubs through the year, which would prolong the problems of other manufacturers and retailers further west.
That is not the only challenge facing China next year. At some stage, the country’s authorities will have to decide who gets to bear the losses on debts owed by China Evergrande Group and other over-extended real estate developers. It will have to do so without triggering panic among domestic retail investors, and, preferably, without resorting to yet more borrowing to spend its way out of a growth slowdown.
Any sign of financial or even social instability may embolden Beijing to distract attention with a little foreign policy adventure: after ending Hong Kong’s autonomy, President Xi Jinping, with what amounts to a fresh mandate from the Communist Party to rule for life, has made no secret of his desire to restore mainland sovereignty over Taiwan.
4. Europe’s Energy Crisis
Geopolitical risk is also one element – but only one element – of another story set to dominate headlines in Europe, especially early on in 2022. The old year is ending with Russian President Vladimir Putin threatening an outright invasion of Ukraine, on the spurious basis that NATO’s eastward expansion is an existential threat to it.
Most analysts have inclined to the view that the military maneuvers on Russia’s border with Ukraine, where over 100,000 troops are currently massed, are ultimately a pressure tactic to ensure the opening of the controversial Nord Stream 2 pipeline, which promises to be a lucrative earner for Gazprom (MCX:GAZP) and its state owners. However, with Putin expressly talking of “military-technical” action in a speech to his defense chiefs on the Tuesday before Christmas, that can no longer be taken as a given.
As in 2008, when oil prices were still above $100 a barrel, Europe’s ability to respond to an invasion would be inhibited by the fact that power and gas prices are already far above previous record highs, due to a shortage of gas in storage, increasing constraints on coal power due to environmental policy, and the declining availability of an aging nuclear fleet that has already been thinned out by environmental zealotry in Germany and elsewhere.
The consequences of wishing an Energy Transition into existence without securing supplies have become painfully obvious.
The looming explosion of household energy bills is already set to add 1% to U.K. inflation in April, when a regulatory price cap is lifted, and is forcing Italy and Spain to extend subsidies previously built into energy bills as an emergency measure. Gas-intensive industries such as fertilizer makers have already been forced to close factories, and the risk is that more will have to as utilities ration supplies through the end of the winter.
5. Can OPEC and the U.S. Keep Pace with Oil Demand?
The spread of Omicron has also suspended all bets on when, precisely, global oil demand will top its pre-pandemic peak, but it seems sure to do so sooner rather than later, asking questions of both OPEC and U.S. policy.
According to data from the American Petroleum Institute, U.S. demand alone was within 0.4% of its peak by November, before the latest wave of infections put a dampener first on air travel and, most likely, road travel too. When demand does finally recover, it’s not clear that supply will be able to keep pace: economic uncertainty and increasing environmental activism by shareholders and governments have led to falling investment in new production. Barring some miracle in the dying days of the year, discoveries will have fallen to their lowest since 1946 in 2021, according to analysis by Rystad Energy.
“Those who believe most recent price inflation is temporary may misunderstand the time required for oil and gas investments,” Dean Foreman, the API’s chief economist, warned in a recent note. Both OPEC and U.S. producers found themselves more concerned with repairing balance sheets than with increasing supply this year. It will likely take a change of heart in both corners to avoid another surge in oil prices in 2022.
6. Crypto’s Watershed Year
The global monetary tightening cycle will provide a stiff test for cryptocurrencies, which have shown an increasingly high correlation to speculative assets in the past year. Speculative assets tend to perform badly when interest rates rise, after all.
However, for those who remain committed to crypto, 2022 promises to be an exciting year, in which the U.S., Europe and India are all expected to clarify the regulatory direction of travel, something that should put the asset class on firmer legal ground.
On a technical level, the event of the year may be the completion of Ethereum’s transition to the Proof-of-Stake mechanism on its blockchain, moving away from the more energy-intensive Proof-of-Work mechanism that constrains scalability (as well as generating heaps of bad press for crypto on environmental grounds). Given Ethereum’s place in the universe of decentralized finance (DeFi) initiatives now multiplying, the importance of the transition can hardly be overstated.
Elsewhere, the progress of Polygon, which provides an infrastructure for different blockchains to communicate with one another, may also expand the ease of use of many coins – although it will make it harder for enthusiasts to argue that the more than 6,000 digital coins now in existence derive their value from their scarcity.Leave a comment