If all goes well this year, the world economy will muddle through to another year of above-average growth as it moves above 2019 levels in a continuing recovery. Whilst there will be some monetary tightening and some reduction in stimulus by the major governments, many companies can look forward to a bit more turnover and further profits growth.
Inflation will be higher than desirable for the first half but will subside in the second, whilst many companies will have sufficient pricing power to offset inflationary effects on their costs. The virus may wax and wane around the world but summer in the northern hemisphere should be largely unlocked.
We will be watching out for any policy error – hiking interest rates too far too soon – were central Banks to panic away from their view that inflation is temporary and will subside. We will also be studying inflation in case it embeds with a wage price spiral, upsetting the central-bank forecasts. We need to keep an eye open for any revival of the virus that could defeat the current vaccines and force more lockdowns for longer. We need, as always, to consider unhelpful events that could worsen the outlook.
Fed comments jolt markets
We saw last week that more-hawkish statements from the Federal Reserve (Fed) about ending quantitative easing and putting rates up a bit more were not taken well by markets. They led to a sharp sell-off in the technology area in particular. We would be surprised if the Fed, European Central Bank (ECB) or the Bank of Japan actually overdid the monetary tightening in panic at inflation overshoots, as Japan still has too little inflation and the other two are strongly committed to the promotion of jobs and recovery parts of their mandates.
There will be some bumps in markets as the Fed and the ECB wean investors off special programmes of money creation and bond buying.
The Peoples Bank of China has tightened substantially and is now having to relax a bit as it does not wish the property crash, which it has engineered, to turn into a wider banking crash. There will be some bumps in markets as the Fed and the ECB wean investors off special programmes of money creation and bond buying, and as bond yields rise a bit more.
The danger of inflation embedding is a bit higher than “policy error” and would lead to the need for a much-tougher monetary policy anyway. Far from seeing an upsurge in unemployment from pandemic lockdowns and reduced activity, labour markets have struggled to get people back to work. We are watching the numbers for people available to work and for pay levels. On both sides of the Atlantic there are political pressures to raise lower pay at the same time as the market is finding it difficult to fill all the vacancies.
Pay settlements important
The sharp rise in general inflation, led by energy prices, could lead to more successful pay claims beginning a wage price spiral. If it turns out that Covid-19 has delivered a lot of early retirements and more people wishing to swing their work life balance further against paid employment, then labour markets will stay tight with more upwards pressure on pay.
A further surge in infections that defeated the vaccines or caused too many serious illnesses in the unvaccinated could lead to more controls and lockdowns.
More likely are cuts to real pay as a temporary inflation surge hits spending power and serves to depress discretionary spend a bit as people find more to pay for the basics. There are limits to how much extra firms can afford to offer as basic pay given the other pressures on their businesses.
We will be monitoring the virus, as a further surge in infections that defeated the vaccines or caused too many serious illnesses in the unvaccinated could lead to more controls and lockdowns. So far, our view that Omicron would prove, on average, to be milder and to be tamed by the vaccines has proved correct, though it has spread rapidly as predicted by epidemiologists. The base case relies on the vaccines working and more vaccinations being administered. Were a new strain to emerge that defeated the vaccines there would be a sell-off in markets and a delay in recovery as the pharmaceutical industry wrestled to find an effective vaccine once more.
Russian and Chinese wildcards
Events can always come to change things. As I write, some are worried about Russian troop movements in Eastern Europe and about the future of Ukraine. Our base case assumes Russia will not risk an open invasion of Ukraine but may well continue to assist the protesters and rebels against Kyiv (Kiev) rule in eastern Ukraine.
Bigger political threats this year come from China pursuing a more-assertive nationalistic policy.
Meanwhile, Russia is extending its influence in Belarus and Kazakhstan at the request of their governments. Were relations with Russia to deteriorate further the European Union would be vulnerable given its dependence on Russian energy supplies. The West has made clear it will not try to take Crimea back by force, as many ethnic Russians living there wish to be part of Russia and a military intervention would be heavily contested by Russia. Nor does the West show any appetite to go to war in eastern Ukraine. President Biden is threatening Mr Putin with tougher sanctions were he to make a military move. Russia is likely to press harder, given the US mistake in Afghanistan and the new Chancellor of Germany, who is untested and needs to consider Germany’s gas supply.
Bigger political threats this year come from China pursuing a more-assertive nationalistic policy. We assume no invasion of Taiwan, given US support for the island, but continuous pressure to consolidate Hong Kong into China and more provocations against Taiwan. This year will see governments on both sides of the Atlantic having to grapple with the realities of their roads to “net zero”, as the public show some resistance to more expensive fossil-fuel energy and to requirements to alter lifestyles.
It should be another year of recovery. The energy crunch should subside in the northern hemisphere as spring brings warmer weather. The year should bring higher interest rates, which is not so good for bonds as the authorities battle to bring inflation down without triggering an economic downturn.
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