The numbers verge on the incomprehensible. Since the pandemic began, central banks have injected $32tn in to markets around the world, equivalent to buying $800m of financial assets every hour of the past 20 months, according to Bank of America. Global equity market capitalisation has soared by $60tn.
But inflation has risen, and, eager to rein in prices, the US Federal Reserve last week announced its asset purchases will come to an end in March, with three interest rate rises likely next year.
Against this backdrop, these are the big questions banks and investors are asking for 2022.
Inflation: if not transitory, then what?
Central banks performed a U-turn on inflation in 2021, shifting from a reassurance that it would be a “transitory” reflection of the post-lockdowns bounceback to an acceptance that it is more persistent. In November, US consumer prices climbed at the fastest pace since 1982, eurozone prices rose by a record 4.9 per cent and UK figures jumped to a 10-year high.
Yet many banks and investors expect a retreat.
Morgan Stanley predicts that even though prices are likely to stay high next year, the rate at which they increase will peak in early 2022 as oil prices subside and supply chain issues ease.
Columbia Threadneedle likewise cites “improvements in the supply chain” as a significant reason why it thinks inflation will “ultimately fall” in 2022. This raises the alarming prospect that the Fed starts pushing up rates just as inflation backs down.
But BlackRock, the world’s largest asset manager, predicts higher inflation will persist “for years to come”.
Goldman Sachs expects core US consumer prices to remain above 4 per cent deep in to next year. Central banks’ willingness to tolerate higher inflation will keep inflation-adjusted bond yields relatively low, which should also provide support for equity markets, it says.
It expects positive returns from global equity markets and negative returns from government bonds for a second year in a row, the first time this combination has happened for half a century.
Central banks have started turning off the taps, or at least signalling that they will next year. Investors are nervous that they will end up clamping down too hard.
David Folkerts-Landau, chief economist at Deutsche Bank, says if inflation fails to moderate, central banks will shift into a “more aggressive monetary tightening stance, causing a sharply negative reaction in financial markets and most likely a significant economic recession”.
UBS says a central bank policy error is one of the “key risks for investors and the global economy in 2022”. Bank of America adds that markets “are moving from a period in which central banks have tried to be predictable and suppress volatility to one in which they will increasingly be the source of surprises”.
Will US equities keep rising?
“Clients say to us that market momentum has peaked, earnings have peaked, liquidity has peaked, central banks will be tightening, you should be taking some profits,” said Mislav Matejka, head of global and European equity strategy at JPMorgan. “We don’t agree with that.”
Goldman Sachs expects the S&P 500 to climb a further 9 per cent by the end of 2022.
Some worry however that gains in equities, particularly in frothier corners of the market, are not sustainable.
Morgan Stanley says its base-case scenario is for the S&P to drop 5 per cent. Bank of America meanwhile predicts that economic deceleration and higher interest rates will drag the main US equity gauge down 3 per cent.
What is the outlook for Europe?
The European Central Bank faces a “difficult and volatile” environment for prices heading into next year, says Frederik Ducrozet, senior strategist at Pictet Wealth Management.
“The broad outlook is one of not just permanently high inflation but also of permanently high inflation volatility,” he said.
The ECB last week committed to scaling back its pandemic-era bond-buying programme in response to higher prices, while reiterating that rate rises will have to wait until 2023.
The consensus expectation, according to data compiled by Bloomberg, is for the Stoxx 600 index to rise 6 per cent as economic growth continues and yields on bonds remain low. Yet Bank of America expects those trends to reverse in 2022, with the Stoxx falling 10 per cent.
Ben Ritchie, head of European equities at Abrdn, the Edinburgh-based asset manager, says investors should focus on businesses with strong competitive positions, pricing power and access to structural growth drivers.
Although valuation multiples for European equities are a challenge, Ritchie says the healthcare, consumer goods and financial sectors offer “plenty of opportunities”.
Pimco, however, predicts that European equities will be “more challenged” owing to a combination of unfavourable sector composition, energy price headwinds, and growing unease around the Covid-19 outlook.
Jordan Rochester, a foreign exchange strategist at Nomura, says upward pressures on energy, food and services prices will mean the headline European inflation rate will remain uncomfortably high next year.
He notes that the price of gas in Europe has risen about 573 per cent this year, reflecting concerns that Germany could run low on supplies over winter. Increases in the cost of gas are driving up fertiliser prices, which are highly correlated with the price of food. Consumers are likely to react to these developments with demands for higher wages, Rochester says.
Watch out for French presidential elections in April.
What next for China and emerging markets?
“Emerging markets had a really horrible year and there are going to be a lot more ugly headlines . . . in part because [China’s] zero-Covid policy is going to be tough to maintain, especially with Omicron,” said Chris Jeffery, multi asset manager and head of rates and inflation at LGIM.
China’s CSI 300 stocks index has fallen 3 per cent this year after policymakers in Beijing imposed new restrictions on technology, education and property companies.
Meanwhile, Claudia Calich, head of emerging markets debt at M&G Investments, says the problems in China’s property sector serve as a reminder of the dangers and fragility that can lurk in Asian corporate bond markets, until recently a growing area of interest for international investors.
Calich added that investors should brace for “significant downside risks” in emerging markets if the severity of the virus proves to be worse than anticipated, particularly among the many nations that still have largely unvaccinated populations.