THE GLOBAL ECONOMY: Capital Economics, an independent economic research consultancy based in London, expects growth in almost every major economy to slow in 2022, with the US and China in particular falling some way short of current expectations. Year-to-Date the Nasdaq is already down 12.51%, firmly in technical correction territory. At the same time, while headline inflation is expected to drop sharply, core inflation will remain higher than most anticipate in a number of countries. This will pose a dilemma for policymakers. Capital Economics expects most central banks to tighten policy in 2022, but in some cases (though notably not the US) the pace of tightening will be a bit slower than investors currently anticipate. China is likely to be one of the few countries in which interest rates are cut. China’s first interest rate cut for 2022 occurred last week.

COVID-19 – EXPECT NEW VARIANTS: Capital Economics expects that the evolution of the covid-19 pandemic will continue to be the most important driver of economic and market outcomes in 2022. Its forecast assumes that the virus will continue to ebb and flow, with new variants emerging and governments responding by tightening (and then loosening) restrictions. In most countries they assume that these will be targeted and less economically disruptive than in the initial phase of the pandemic, but stricter measures are clearly possible if more dangerous strains emerge and/or healthcare systems become overwhelmed.

ZERO-COVID: Those economies that continue to follow “zero-COVID” strategies (notably China) will respond with localised lockdowns and tighter restrictions on regional travel as outbreaks emerge. This will make for a more volatile path of output in these countries. The uncertainty surrounding the pandemic means that the risks around their central forecasts will continue to be unusually large. Indeed, while there is a tendency to focus on the downside risks from new variants of the virus, it’s possible that in 2022 it could mutate into a less deadly form that is ultimately positive for economic growth.

ECONOMIC GROWTH WILL DISAPPOINT: Capital Economics thinks 2022 will be a year in which economic growth disappoints. In the US, it expects demand to remain strong but thinks that supply constraints will put a firmer brake on output than most analysts currently anticipate. In China, it expects the construction-led slowdown to intensify. In Emerging Markets (EMs), it expects a combination of tighter policy, lower commodity prices and continuing virus disruption to weigh on growth. It is more upbeat than the consensus in a handful of economies, including Australia. But overall, GDP forecasts sit below most expectations. While the IMF expects global GDP to expand by nearly 5% in 2022, Capital Economics expects growth to be closer to 4% (compared to 6% in 2021).

INFLATION WILL DROP: While Capital Economics expects headline inflation to fall back everywhere, it expects that core inflation will remain uncomfortably high in a number of countries. The sharp increase in energy inflation, which contributed to last year’s surge in inflation, will unwind in 2022. But in most advanced economies a combination of strong demand and lingering supply shortages means that core inflation is unlikely to ease as quickly as policymakers expect. Some of the heat will come out of the inflation debate, but it will continue to be the key issue for policymakers and markets.

INTEREST RATES WILL INCREASE: Capital Economics expects most central banks to tighten policy in 2022. The Federal Reserve’s fed funds rate is expected to increase at a similar pace to bond markets in 2022 (and at a faster pace in 2023). But in several other countries, including the UK, Australia, Brazil and South Africa, the pace of tightening will be slower than investors currently anticipate. Expect interest rates to remain at current record lows in the euro-zone and Japan. As mentioned above, the People’s Bank of China has already started to cut policy rates. Bloomberg expects the South African economy to grow 1.6% in 2022 and that the SA Reserve Bank will continue to hike interest rates.

SUMMARY – 2022 WILL BE CHALLENGING: Although the combination of a strong economic recovery and accommodative monetary policy has fuelled healthy returns for many investors over the past 18 months or so, Capital Economics argues that the macroeconomic backdrop is now becoming more challenging. A combination of monetary tightening and stubbornly high inflation will mean returns on US Treasuries are likely to be negative and that those from government bonds in other Developed Markets (DMs) will be only slightly positive. Returns from equities and commercial property will be higher, but high valuations and weaker growth will cause them to fall well short of returns in 2021. And while many analysts are forecasting the start of a new commodities super cycle, Capital Economics expects most commodity prices to fall in 2022. In currency markets, it expects the dollar to strengthen a bit further against other majors, but by less than its ~7% rise in 2021. We will revisit these forecasts at the end of the year – it will be interesting to see the divergence between the forecasts and actual performance. A Black Swan or Gray Rhino event, like a Russian invasion of the Ukraine, or a Chinese invasion of Taiwan, will radically affect the above scenarios. The VIX (fear index) is already standing at 29.90, up 80.12% Year-to-Date.