Newsletter
Feb 2022
Economic conditions
The world economy is continuing recovery from the shock of the Corona virus. It is increasingly clear that the latest variant is much less dangerous than those that have been before. World economic growth is accelerating. However,there are concerns about China and the action of central banks to raise interest rates to combat inflation.
Economic activity in China has already decelerated and there are fears that this might spread to the US and other parts of the world. Bankruptcies in the Chinese property market have slowed lending and are spreading to other sectors. International equity prices remain underpinned by the rebound in growth and the rise in profits. Inflation is the market focus. If cost pressure (particularly wages) do not subside there will be prolonged inflation to prompt more aggressive monetary tightening or a squeeze on profit margins.
As such, the evolution of inflation will be key for 2022. Central banks have been holding back from increasing interest rates aggressively. However, if inflation does not fall or if there is any evidence of longer-term inflation expectations rising, the probability of more robust monetary action and consequent risks for the global economy will rise. The US is the focus here with aggressive fiscal and monetary action driving the world economy through the strong demand in America.
The flow of US demand abroad has caused a deterioration in the US trade balance that will not reduce the trade friction between the US and China. The prospect of further US fiscal stimulus limited due to the impasse in the US Senate. The political gridlock is expected to become more entrenched if the Democrats lose the Lower House as a consequence of the Mid-Term elections in November 2022.
US-Chinese trade; Russian armies in Easter Europe, global warming are also important for emerging equities in the year ahead.
Projections
| Indicator | 2021 | 2022 | 2023 | 2024 |
|---|---|---|---|---|
| World growth | 5.6 | 3.5 | 4.0 | 4.0 |
| US GDP | 6.5 | 3.5 | 3.0 | 2.5 |
| US Inflation | 4.0 | 3.5 | 3.0 | 2.0 |
| US Unemployment | 5.5 | 4.0 | 4.0 | 4.0 |
| US bond yield | 1.5 | 2.0 | 2.5 | 2.5 |
Upcoming events
- US interest rate outlook: The Federal Reserve has indicated that there will be three or four rate increases in 2022. Market expectations are that rates will rise sharply in the near term but will plateau in 2023. Central bank bond purchases will be cut back to zero by the end of the first quarter of 2022. The speed with which the balance sheet is unwound will be watched with interest. It is another risk.
Assets
US Stocks (SPY) and those in the rest of the world are already pricing in economic recovery. The price of US equities relative to the earnings that have been reported is close to a record high. Substantial improvement in earning will be necessary to maintain current price levels. Emerging equities are less highly valued but rising US interest rates may cause capital flight and increased funding costs. Chinese economic weakness has not spread abroad but the size of the economy means that China cannot be ignored.
US government Bonds (TLT): the 10-year government yield has pierced the 2.0% level but this yield reflects a belief that the US central bank will contain inflation without substantial tightening of monetary conditions. This will may be a challenge.
Gold (GLD): is drifting with an easing of the virus and suggestions that Crypto assets are the new safe haven from inflation. However, Crypto regulation or an increase in international conflict could reignite the yellow metal.
Corporate bonds (JNK): are supported by the low level of defaults. The spread between safe and risky assets has tended to narrow as investors search for yield. Higher interest rates would be negative in absolute terms and would raise refinancing costs and therefore default risks.