Outlook for 2022: A resilient economy despite the persistent effects of COVID-19

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If 2020 was the year of COVID-19, 2021 will go down as the year of vaccines. How has their arrival played out in macroeconomic terms?

The lockdowns of 2020 paralysed economies across the globe. In April last year, PMIs – which reflect the prevailing direction of economic trends – tumbled from 55 to 15. Yet global vaccination programmes have restored confidence among purchasing managers: following a sharp uptick and a slight slump, the index moved above 55 in October 2021 for both the eurozone and the United States. A reading above 50 indicates an expanding economy. In China and emerging markets, PMIs dipped to between 45 and 50 before recovering some lost ground in October 2021.

The arrival of vaccines has therefore proved a shot in the arm for the global economy. Eurozone and U.S. vaccination rates are respectable – although they could be even higher – but achieving maximum coverage appears to be a much tougher challenge: the numbers are still climbing, but the pace of growth is slowing.  Yet as 2021 draws to a close, Europe is battling a fresh wave of infections. Case numbers are roughly where they were a year ago but, thanks to the vaccines, hospitalisations are much lower – at least for the time being. The situation is nevertheless concerning and things seem to be getting worse, prompting governments to reimpose restrictions, albeit not as draconian as in previous lockdowns.

Is the recovery on track?

The year opened with a slight contraction as the effects of the second lockdown took hold. With the buoyant growth we saw in Q2 and Q3 came an unexpected burst of inflation, which has hit levels not seen since the financial crisis. There are two reasons for this. First, oil, gas and electricity prices have soared. And second, the prices of manufactured goods have surged amid a supply-demand mismatch caused by supply-chain bottlenecks. Although there are no signs of an imminent cooling on the horizon, these two inflationary pressures should ease as time passes. Central banks have been hammering home that message for the past few months, although they admit inflation hasn't been as temporary as they anticipated.

The likely outcome is that, once things cool down, inflation will settle well above pre-pandemic levels. This combination of high inflation, persistent supply-chain bottlenecks and a fresh wave of infections will dampen economic growth in Q4 and into the early part of next year. In cyclical terms, we're entering a period of more moderate economic growth coupled with high inflation, although it'll be nothing like the stagflation we saw in the 1970s. We probably haven't reached the end of the current business cycle just yet. Growth is expected to remain above trend in 2022 before settling at a rate more in line with long-term potential.

Does the picture look different across regions?

The NextGenerationEU recovery plan kicks into gear this year. It's a much-needed boost for eurozone economies, especially countries such as Spain and Italy that were hit hardest by the first lockdown and – in the case of Spain in particular – have struggled to recover as tourists have stayed away. The plan signals a genuine commitment to building back better than in the aftermath of the 2008 crisis. In terms of GDP, several countries including Belgium, France and the Netherlands had almost or fully recovered to pre-pandemic levels by the end of Q3 2021.

In the United States, the Democrats' clean sweep – taking the presidency and both houses of Congress – opened the floodgates for extremely generous support packages for households and jobseekers. Government stimulus checks boosted consumer spending, especially on capital goods, causing the economy to overheat and sending inflation skyrocketing. The U.S. economy is still expanding steadily, albeit at a slower pace, while inflation maintains its upward trajectory. As in Europe, some of the underlying factors are temporary. But others are more structural in nature. Household spending is expected to remain high as wages increase and the labour market improves, while strong equity performance is helping to fuel the wealth effect.

China bucked the trend this year, putting in a disappointing showing with growth slowing sharply. The evolving COVID-19 situation was partly to blame, as the country grappled with a fresh wave of infections, pursued a zero-COVID policy and lagged behind with its vaccination programme. The manufacturing sector was hit by bottlenecks, rising energy prices and the temporary closure of the heaviest-polluting coal-fired power plants. But the biggest factor was Beijing's regulatory crackdown on the tech industry and other sectors, coupled with measures to rein in real estate lending growth amid the Evergrande crisis. Yet these largely domestic issues have had little effect on foreign trade, which is what keeps the wheels of the world's manufacturing powerhouse turning.

Central banks have taken unprecedented steps in the past two years. Are they getting it right?

It's important to remember that the economy collapsed at the end of Q1 2020. Without support from governments, the European Central Bank (ECB), the Federal Reserve and other central banks, it may never have recovered. Beijing took a different approach, propping up the Chinese economy through loans to big businesses. These measures prevented the worst from happening.

The challenge facing central banks through the remainder of this year and into early 2022 is to begin normalising monetary policy. That won't be an easy task. As announced, the Fed has already started gradually scaling back its bond-buying programme, while rate hikes could come earlier than anticipated as it tightens its monetary stance. Meanwhile, the ECB's symmetric inflation target appears to rule out tightening in the immediate future, although the bank is predicted to start notching up interest rates in the longer term as it seeks to curb ongoing inflationary pressures. That said, expectations are for little or no movement in European benchmark interest rates throughout 2022. The ECB is, however, likely to wind down its bond-buying programme as the effects of the COVID-19 crisis ease.

“The arrival of vaccines has proved a shot in the arm for the global economy."

How do you see 2022 shaping up?

As I said earlier, cyclical growth should continue throughout 2022. The economy won't expand at anything like the pace we saw in 2021, but growth will still be above the long-term trend. We expect consumer demand to remain high, with fewer people out of work, and with households spending the money they saved during the lockdowns and borrowing more to take advantage of low interest rates.

The main downside risk is the inflationary spike, which we expect to persist through the first half of next year. Even if price pressures ease upstream, this may not work its way through the chain while demand continues to outstrip supply. In short, households may be complaining about rising prices, but they're still spending. Recent developments have taken some of the edge off this risk, with governments introducing fresh restrictions, COVID-19 hospitalisations climbing, and a new, potentially more transmissible and more severe variant emerging. It's reassuring to note that the economy has proved resilient and adaptable, despite these stumbling blocks.

What does 2022 have in store on the monetary policy front?

In the United States, we're expecting benchmark interest rates to move upwards – short-term - 2-year - rates will likely increase, while long-term -10-year - rates will probably climb at a steeper pace. That means curves will be higher but tend to flatten. In Europe, meanwhile, the ECB should keep benchmark rates unchanged for longer than the Fed. So when hikes start, they're expected to be steeper. In absolute terms, interest rates will remain low overall but we're likely to see some volatility as policymakers respond to circumstances – just as they are with inflationary pressures and the COVID-19 crisis right now. On a broader note, pent-up demand from cash-rich households and businesses will maintain pressure on interest rates in Europe.

How will these developments affect different asset classes, starting with bonds?

Investors will have little appetite for fixed-income securities in 2022, as was the case this year. Yields should maintain their modest upward trajectory as we move through the economic cycle, but stay low in absolute terms. Sovereign bonds will therefore struggle to appeal.

High-quality corporate bonds will retain more value, relatively speaking, but credit spreads remain very tight. Investment-grade emerging market debt – dollar-denominated and hedged against foreign exchange risk – is a slightly more attractive proposition. Investors can also turn to bonds that offer higher yields but carry higher risk as a way to maximise potential returns. And more generally, illiquid investments with low credit risk are still a good alternative.

How about equities?

On the face of it, the hectic activity we're seeing in the stock markets is enough to drive investors to distraction. But it was corporate earnings that provided the real good news story in 2021, with firms smashing even the most optimistic forecasts quarter after quarter. That even happened in Q3, despite supply-chain bottlenecks and the looming spectre of inflation. Why? Because many firms – not all, and not in every sector, of course – saw a sharp uptick in order volumes driven by strong demand, and were able to pass on a large share of their increased costs to customers - so-called “pricing power". If you compare the equity price rises we saw in 2021 with firms' upwardly revised earnings forecasts, there's a neat correlation between the two. That means there's been little change in price-to-earnings and other valuation ratios. In other words, stocks are no more expensive than they were at the start of the year.

It remains to be seen whether we'll see earnings forecasts revised upwards again in the next few quarters. That seems to be the view among analysts, who feel that current forecasts for the coming years are too conservative. While that bodes well for the future, it's worth remembering that 2021 was a vintage year and we're unlikely to a repeat in 2022. The cocktail of pandemic, inflation and interest rates could well put a damper on proceedings. Let's just hope it doesn't spoil the party altogether. Our expectation is for moderately positive returns, given current valuations. Interim consolidated statements might be a good place to start.

"We probably haven't reached the end of the current business cycle just yet. Growth is expected to remain above trend in 2022 before settling at a rate more in line with long-term potential."

How do you see things panning out in the longer term?

The pandemic has changed various aspects of our lives and working practices. And while mass vaccination programmes have allowed much of the economy to reopen, some sectors and industries remain vulnerable to fresh restrictions. We've learned to live with the virus and, for many of us, showing COVID passes has become second nature. There are other health and safety measures in the pipeline, but things are unlikely to return to normal in 2022. With social distancing rules still in place, we're likely to see digital technology creeping into even more areas of our lives. We can already see that happening with things like artificial intelligence and smart electric vehicles. Then there's the buzz around the metaverse, which is heralded as the future of the internet – a persistent virtual environment where we'll be able to interact with others in 3D. And last but not least, we'll all need to change our behaviours as the world transitions to a clean-energy, low-carbon future.

"We've learned to live with the virus and, for many of us, showing COVID passes has become second nature. There are other health and safety in the pipeline, but we're unlikely to see a return to normal in 2022."​
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