Global economy

Anchor: pandenomics

Transition in progress

The global pandemic is not yet over but vaccinations have helped bring back some normality to everyday life. Although the rapid spread of the COVID-19 Delta variant slowed the pace of economic normalization in some places in 2021, the recovery should continue in 2022 with expected above potential growth in global gross domestic product (GDP). That said, the post-pandemic normalization will be different from past crises. A recession like no other will bring a unique recovery. In summary, there is much more to learn about the pandemic economy in the coming quarters.

The last two years have been extraordinary – not only for humanity but also for the global economy. Despite the fact that the COVID-19 pandemic now appears more under control thanks to vaccination programs, parts of the global economy, e.g. labor markets, have yet to stage a full recovery. Business as usual remains unusual – and will stay so for the foreseeable future.

When COVID-19 evolved into a global pandemic in 2020, the ensuing lockdowns sent the global economy into the steepest recession on record. This unprecedented shock led to extraordinary fiscal and monetary support, which helped to trigger a sharp recovery. However, the size of the economic shock resulted in unrecognizable data and a “data fog,” which made it difficult to interpret and even more difficult to forecast, leading to a wide dispersion in views among investors. In the USA, labor market statistics like initial jobless claims rose to levels previously unthinkable, while in financial markets, oil prices briefly turned negative, to name just two examples.

The recovery from the crisis continued into 2021, driven by strong stimulus effects and pent-up demand. Inflation rose as well – in part due to so-called base effects, i.e. the data fog issues, as well as ongoing supply chain issues, i.e. shortages of goods ranging from computer chips to softwood lumber that were caused by COVID-19 related closures of factories and ports. Toward the end of 2021, some central banks had enough confidence in the economic recovery to start reducing some of the emergency stimulus by slowing down asset purchases (tapering). In 2022, we expect a reduction in the data fog as economic activity further normalizes. However, not all features of the pandemic economy will be transitory. In our view, the coming year will be more “normal” than 2021, but with plenty of special factors still at work. We believe that the economy that will ultimately emerge from this crisis will be profoundly different from 2019, with the most important changes likely to be unrelated to the pandemic.

Solid growth despite supply chain challenges

In terms of economic growth, 2022 looks set to be a good year, driven by the same factors that already supported the economic recovery in 2021: solid demand, a still supportive fiscal and monetary policy environment and the continued relaxation of COVID-19 related restrictions that will help industries such as tourism and travel. We expect the global economy to grow by 4.3% in real terms in 2022. This is less than the 5.8% we expect for 2021 but higher than the growth rate before the pandemic. For example, the global economy grew by 2.7% in 2019.

Global industrial production (IP) looks set to improve. The unprecedented boom in goods spending during the recovery has been fueled by diverted income that would have usually gone into services but did not due to COVID-19 restrictions on sectors such as tourism and restaurants, sufficient stimulus to lift disposable income despite falling labor income, and unusually high demand for some goods such as electronics. During the 2020 recession, IP fell more than total goods demand, and production always lagged behind consumption throughout the recovery.

As a result, inventories throughout the global economy have been drawn down. Some of these shortfalls in production are related to COVID-19 measures and are likely to improve as restrictions are lifted. Others look set to persist in 2022, particularly those that require new business investments (i.e. factories) to ramp up production such as computer chips. Labor shortage issues, such as the lack of truck drivers that is causing problems in the UK, will likely remain a challenge in the coming year. Overall, however, we expect supply chain issues to be less of an acute problem in 2022 than in 2021.

While IP is one side of the recovery story, the larger part of the global economy consists of services. Services spending has not fully recovered because social distancing continues to affect many sectors including restaurants and tourism. Alongside the overall recovery of the economy, however, services clearly improved in 2021 and we think the recovery is likely to continue in 2022 as more restrictions are lifted. We therefore expect services to grow faster than the overall economy in 2022. The good growth prospects for both IP and services mean that the global economy should be able to digest the gradual withdrawal of emergency fiscal stimulus (e.g. special unemployment benefits or furlough schemes) and central bank support.

Inflation: Leveling off but still elevated

The acceleration of inflation was one of the key themes of 2021. The pandemic initially acted as a strong deflationary shock. Many prices initially fell (e.g. West Texas Intermediate crude futures briefly turned negative for the first time in history in April 2020). Fearing a deflationary spiral and depression-like conditions similar to the 1930s, policymakers reacted swiftly and forcefully, ushering in monetary and fiscal stimulus of unprecedented size. These reflationary policies helped to put the economy back on track. In turn, the strong goods demand coupled with pandemic disruptions that overwhelmed many supply chains have led to sharp increases in core goods inflation. We estimate that global inflation rates – being a measure of the change in prices – increased by 3.5% in 2021.

The rate of change in price levels should start to peak going forward. This is because much of the initial recovery in prices is now behind us (i.e. base effects are fading), while there should be fewer supply chain disruptions ahead.

However, other factors will likely prevent inflation rates from falling all the way back to pre-pandemic levels. One of these factors is the tightness of labor markets. The economic recovery in 2021 helped to bring back many jobs, and unemployment rates in many countries are close to levels prior to the pandemic. With the expected recovery in the services economy in 2022, we think the labor market could quickly become tight with demographics exacerbating the issue in many countries. In fact, we already see labor shortages in everything from bus and truck drivers to substitute teachers and restaurant workers. Tight labor markets should improve the bargaining power of workers in wage negotiations. Consequently, while we expect inflation to decline as the year 2022 progresses, this should ensure that the annual average rate of inflation stays elevated at 3.7%. In 2019, global inflation stood at 2.5%.
To hike or not to hike?

With inflation in many regions likely to remain above central banks’ targets in 2022 (we forecast, for example, inflation rates of 4.5% for the USA and 2.8% for the Eurozone), one of the key questions will be how central banks will respond. During the pandemic, all of the major central banks implemented significant asset purchasing programs (quantitative easing) to supply financial markets with ample liquidity and keep financial conditions supportive for the economic recovery. We believe that many central banks will start reducing their asset purchases before they turn to hiking interest rates. Indeed, several central banks, including the US Federal Reserve (Fed) started to do just that in late 2021. In their communications, central banks have made it clear that any reduction in their asset purchase programs will depend on the economic data, and they will carry it out in a way that will not threaten the economic recovery.

High (but falling) core inflation and strong progress toward full employment in 2022, amid market expectations of imminent tightening, is likely to deliver one rate hike from the Fed by the end of 2022. In the Eurozone, the European Central Bank (ECB) is likely to end its Pandemic Emergency Purchase Programme (PEPP) in June 2022, in our view, but it should continue to buy assets throughout the year through more conventional programs. The situation is slightly different in the UK. In the UK, where inflation is a bit stickier than in the rest of Europe, we expect the Bank of England to start hiking rates in December 2021 and then twice in 2022. In summary, we will likely see some rate hikes in selected countries, but we expect the Fed to only hike once while the ECB sticks to reducing asset purchases and leaves interest rates unchanged for the time being.
The impact on financial markets

As inflation rates level off, and central banks reduce asset purchases and increase rates, real interest rates (nominal interest rates minus inflation) could rise in 2022. Rising real interest rates usually mean that financial market returns (notably bond returns) will likely be lower, while financial market volatility is usually higher. Rising real interest rates also negatively affect the ability of governments and households to service their debt, which is why central banks will closely monitor this development and make sure it remains manageable.

Overall, we believe that 2022 will be a year of recovery and transition from the pandemic. Growth looks set to stay quite robust and labor markets should tighten. A slight increase in real interest rates and ongoing – although less severe – supply chain problems are risks that could lead to financial market volatility and need to be carefully monitored by policymakers and investors alike. Nevertheless, it is very likely that 2022 will be a much more normal year than 2020 and 2021. That said, longer-term factors such as climate change, shifting demographics and new technologies mean that we will be transitioning toward something new in the post-COVID world. Overall, 2022 will mark the start of a transition to the post-COVID decade.
The post-COVID decade

In many respects, the COVID-19 pandemic was an unprecedented shock to the global economy that led global policymakers and businesses into uncharted waters. While many elements of this shock (e.g. the lockdowns) are clearly temporary, others (e.g. the substantially increased levels of government debt) look set to be of a longer-lasting nature. At the same time, important trends such as climate change and shifting demographics have reached a level of urgency that could very well result in a permanent change of the current economic order.

So what could the new “normalized” post-pandemic world economy look like? In our view, the future will be shaped by new factors including: shifting demographics; more state capitalism; expensive problems like the energy transition; and new disruptive technologies. In terms of demographics, we have now reached a situation where the working age population in most parts of the world except Africa is stagnating as populations age. This should lead to tighter labor markets, providing workers with more bargaining power that could lead to increased wage growth. As a result, companies are likely to step up investments in automation and other measures to boost labor productivity.

Looking at the labor market in more detail, many middle class jobs in developed markets have vanished over the last 20 years, while there has been a simultaneous increase in both high- and low-paying jobs. This has led to an increase in wealth and income inequalities, which governments are likely to address by redistributing income through new taxes or new regulations. We already see this trend today in China, where the government has adopted a set of new “common prosperity” policies, effectively changing priorities from a growth-first mindset toward one of increased equality. We see similar developments in developed countries including the USA, which could lead to increased state capitalism, i.e. government involvement in business.

Additionally, policymakers will have to deal with “expensive problems.” An aging population’s rising health expenses, the energy transition toward renewables and developed countries’ long overdue infrastructure overhaul are just a few of the most pressing examples. All these topics require substantial investments at a time when government budgets are already under pressure. Worryingly for governments, strained budgets could also limit their ability to smooth out future economic downturns.

If there is good news, it is likely on the technological frontier. New technologies such as quantum computing or Blockchain applications could help to address some of these problems while simultaneously putting pressure on traditional business models. For example, Blockchain technology could revolutionize payment systems, as well as banking and wealth management.

Overall, we think the “normalized” post-pandemic world will be one where economic growth will be more erratic and volatile but not necessarily lower or higher than before. We expect a return of the economic boom-bust cycles of the past. We are likely to see an unwinding of liberal policies such as free trade and low corporate taxes. Instead, new regulations and taxes and increased income redistribution could lead to a less steady business climate and add to the economic volatility. As a result, inflation is likely to be higher than it was over the past 20 years, but hyperinflation seems unlikely. Investments in climate measures, automation, infrastructure and new technologies could lead to a meaningful increase in labor productivity but also to increased government debt. Banks are likely to help finance government deficits by holding more government bonds. At the same time, Blockchain technology and central bank digital currencies are likely to transform the financial industry to its core. In terms of political developments, the rivalry between the USA and China looks set to stay firmly in place, while the political divide in Western Economies could deepen further. In summary, the next decade will be marked by the end of the “Great Moderation” of recent decades, with 2022 being the year where the first developments become visible.

Regional outlook

Shifting to a lower gear

We expect real GDP growth of 3.8% in 2022, but a halting services rebound and ongoing supply chain issues are complicating the final stages of the pandemic recovery. Inflation is expected to slow to 4.5% after an extreme spike earlier in 2021, but risks remain to the upside.

Global supply chain shocks could lead to more strength in goods prices in the near term, and lead indicators for shelter inflation have picked up significantly. The Fed is beginning to gradually remove accommodative policies. Tapering of asset purchases will begin in mid-November 2021 and continue into the middle of next year. High (but falling) core inflation and strong progress toward full employment in 2022, amid market expectations of imminent tightening, is likely to deliver one rate hike from the Fed by the end of next year. In terms of politics, the Biden administration’s infrastructure package will support growth in 2022. There could also be renewed political gridlock ahead if Democrats lose the midterm elections in 2022.

Losing steam

We project that real GDP in Latin America will grow at an annual average rate of 1.8% in 2022 following 6.4% growth in 2021. While this represents a significant slowdown, growth remains above pre-pandemic levels of 0.7% in 2019.

We forecast annual regional inflation at 10.3% in 2022, with higher commodity prices, supply-side bottlenecks and FX pass-through being the main drivers. As of late September 2021, approximately 60% of the population in the countries under our coverage had received at least one COVID-19 vaccine dose.

Generally, growth rates look set to diverge across the region: Colombia, Peru and Mexico should exhibit the strongest growth rates, while Brazil looks set to lag the region due to strong monetary tightening and the uncertain political outlook.

Bank of England on track to hike rates twice in 2022

The UK recovered at an impressive pace in 2021, as the quick vaccine rollout allowed for most pandemic restrictions to be eased. However, there are signs that growth is losing momentum. We expect real GDP growth of 5.0% in 2022 versus 7.0% in 2021. Some of this slowdown was expected as the initial boost from the reopening fades. However, labor shortages and supply bottlenecks are also causing a loss of momentum in the recovery, along with a record rise in firms’ costs. While some factors causing labor shortages like COVID-19 self-isolation rules should unwind, Brexit could lead to a permanent decline in the labor supply. While demand should continue to be supported by the reopening of the economy and the high share of consumer savings, we think that higher inflation, the end of the furlough scheme in September 2021 and the withdrawal of other fiscal support measures are likely to weigh on consumer and business spending. Inflation is expected to remain above target due to rising energy and food prices, higher goods prices due to supply bottlenecks, rising services prices due to the reopening and the reversal of value-added tax cuts. Given the persistence of above-target inflation and the Bank of England’s hawkish rhetoric of late, we expect the BoE to start hiking rates in December 2021, followed by two more increases in 2022.

Supply issues slow the recovery

Leading indicators continue to point to solid growth in the coming months, while a decline in the unemployment rate should support consumer spending. Furthermore, elevated domestic demand for goods will now likely persist for longer than we had previously forecast as a result of various supply delays.

Consequently, we do not anticipate that demand for goods will flatten meaningfully until mid-2022. However, there could then be quite a steep slump due to the future threat of saturation and the possible destocking on the part of companies. As is the case in most economies, consumer price inflation accelerated over the summer.

However, it remained well within the Swiss National Bank’s definition of price stability. As a result, we expect the SNB to maintain its expansionary monetary policy. We forecast real GDP growth of 2.5% in 2022 versus 3.5% in 2021, while inflation should remain unchanged in 2022.

Same, but different

A successful vaccination program appears to have contained the health crisis in the Eurozone. The economy has reopened and is growing quickly but continues to lag developments in the USA. Supply chain problems are restraining industrial output, which we expect to surge once those issues are resolved.

In the meantime, they are causing a sharp rise in headline and core inflation. The ECB should pare back its asset purchase program in the coming months. Sustained high inflation and looser fiscal policies could lead to hawkish guidance on rates beyond next year.

In terms of politics, the formation of what is expected to be a center-left led government in Germany may support making the EU Recovery Fund a permanent fiscal mechanism. So there is scope for a material step forward in European integration next year.

A fresh start?

Japan went through a leadership change in 2021, and the new cabinet has quickly started to work on a new stimulus package to support the economic recovery. This stimulus package could come into effect as soon as January 2022. We anticipate the total size of the package will likely amount to JPY 20–30 trillion, including provisions for future use. Small businesses in the services sector, low-income households, medical and pharmaceutical industries, agriculture and fishery industries, the tourism industry and local governments with weak financial positions will be the main targets of subsidies and credit enhancing measures. Money will also be set aside for aid to the renewable energy sector and nuclear power generation. The majority of measures to be included in the supplementary budget will be extensions and expansions of existing ones, which lack fresh ideas to boost demand. Another area of focus after the leadership change will be national security and defense. The geopolitical environment surrounding the country is changing rapidly, and the new government may decide to increase fiscal spending on national security substantially. We forecast real GDP growth of 1.7% in 2022 from 2.0% in 2021, and inflation of 0.5% in 2022 versus -0.2% in 2021.

Common prosperity and net-zero emissions

For most of 2021, China saw a strong recovery in growth before experiencing a renewed slowdown due to problems in the real estate sector as well as regulatory change and policy reforms. Authorities aim to gain regulatory oversight and control of the most valuable assets of key growth sectors. The real estate market is among the targeted sectors. While we did not anticipate that one of China’s largest property developers would face possible default, we do not see a crisis in the real estate market over the next 6–12 months.

The Chinese authorities have already reacted to the solvency risks in the property market to prevent wider contagion. In the long run, however, demographic trends will likely apply downward pressure on housing prices, which could fall faster than expected. In terms of consumption, we expect the household consumption recovery to lag behind, weighed down by the recent regulations and the fact that households' debt service ratio is already at the high end – around 32%, based on our estimates.

Inflation pressure is building in China on the producer price index (PPI) front but the pass-through to the consumer price index has been limited. Finally, China has unveiled an ambitious net-zero emission target by 2060. We expect it to have a very limited (negative) impact on 2021 GDP, while the medium-term impact depends on authorities’ chosen strategies (i.e. whether they choose to reform electricity prices or allow sustainable energy to be used alongside the current energy infrastructure), which could either boost or weigh on growth.

Investment Outlook 2022

Main asset classes

We expect earnings to be the key driver of equity returns in 2022.

Supertrends post-COVID era

Thematic funds are a rapidly expanding niche that has evolved in recent decades from targeted sector and sub sector investments.

ESG Trends

The increased focus on environmental, social and governance (ESG) themes in 2021 will continue to influence both companies and the investment outlook in 2022.

Print Scroll Up