Transitory Inflation Risk
In our transitory inflation risk scenario, current inflation fears prove to be overblown, with inflation gradually coming off its current highs towards something close to or below 2%. We see growth higher than normal in this environment, ultimately pointing to economies being earlier in the cycle than we currently judge them.
Persistent Inflationary Risk
In our persistent inflationary risk scenario, developed central banks’ messaging fails to convince markets that inflation is transitory, with further elevated prints throughout 2022. We see the problem as stemming from a combination of elevated demand driven by past monetary expansion and supply-side disruptions. This causes inflation expectations to become unanchored, with medium-term expectations rising above the 4% mark persistently. This would signal a loss of credibility for those central banks, requiring action that prompts a significant risk of ending the current economic cycle.
Normalization Under Way
While our base case for the global economy may resemble a mid-cycle slowdown, we believe that pandemic-driven disruptions have significantly altered traditional business cycle analysis. Instead, we view the path ahead as one of transition, marked by a period of continued growth but with a falling rate of change as economies digest the pandemic’s extraordinary policy actions. 2022 looks set to be a year of transition as economies return to structural growth rates.
The world’s increasing immunity to the coronavirus
Whether through past infection or vaccination, people around the world are gaining immunity to the coronavirus, as confirmed in seroprevalence studies.
While we remain wary of the potential of a new mutation of the virus, at present, COVID-19 is increasingly less of a concern in our outlook as the economic impacts of the virus continue to fade – though with fits and starts along the way.
However, an uptick in cases in some countries remains a risk that could be accompanied by lockdowns and supply chain disruptions.
Growth is likely to return to trend
Following recovery from the pandemic, we see economic growth normalizing
In 2022, we expect a gradual transition away from policy-led changes in growth. Instead, we see a return to more normal growth rates as business and household spending patterns normalize.
The continued drawdown of unusually high household savings is likely to offset fiscal tightening, allowing for a further release of pent-up demand.
Emerging market growth is likely to diverge from developed markets
Recovery and reopening to proceed in emerging markets on the back of rising immunity.
In emerging markets, we see growth picking up relative to developed markets as immunity to the coronavirus is acquired, and the US dollar remains relatively neutral.
Monetary policy tightening also appears relatively advanced in many emerging market economies. We expect further emerging market policy changes to reflect country-specific growth and inflation pressures as the US Federal Reserve normalizes in line with its guidance.
Inflation is likely on track to peak in mid-2022
Economic data signals slowing inflation is likely.
We see inflation continuing to rise until peaking in mid-2022, followed thereafter by high but falling readings.
We are encouraged by falling money supply growth. When viewed as a precursor to inflation, this suggests fewer inflation pressures ahead.
Moreover, COVID-19 resulted in a concentration of spending in durables while supply chains became strained, resulting in heightened price pressures that appear to be resolving slowly.
Risk scenario: Inflation proves transitory in the short term
If inflation has already peaked, we figure more dovish policy and greater growth potential
Factors that could cause inflation to moderate in 2022.
Temporary supply-side issues fading. Commodity and freight prices are partly surging on temporary, pandemic-induced supply factors. We believe this to be transitory. Prices appear to have already peaked for used cars, many commodities, freight, and a number of other goods. Slack remains.
Capacity utilization remains depressed, indicating supply-side slack. We also anticipate labor market normalization as more workers return to the workforce, alleviating some wage pressure. Spending reorienting. Spending had shifted into goods due to social distancing. As reopening continues, spending is likely to continue to rebalance more to services. Pent-up demand is fading. Pent-up demand has been elongated by supply chain issues. Its impact on inflation should be a one-off and relatively short-lived factor. Fiscal stimulus is fading. Fiscal stimulus is expected to drop in 2022, which is likely to reduce overheating risk.
In this scenario, we hypothesize that current fears of inflation prove to be excessive, with inflation in major developed countries falling to 2% or below.
We see growth higher than normal in this environment, ultimately pointing to economies being earlier in the cycle than we currently judge, which would cause us to favour cyclical assets.
Risk scenario: Inflation persists without cooling
If inflation prints continue at their high rate, we see Fed action in play
In this scenario, we see persistently high inflation leading to an unanchoring of inflation expectations above the 4% mark. We expect this to force developed market central banks into a more hawkish policy pivot.
In this environment, we would expect a curtailment of the economic cycle and would favour defensive assets.