Five key questions for 2022

A number of competing forces will act on global growth in 2022. Given its profound impact on the economy over the last two years, the path of the pandemic remains pivotal. We consider five key questions that will impact financial markets.

Question #1 – How much will Covid-19 disrupt growth?

Early data suggest that the Omicron variant of Covid-19 is highly transmissible, and that it is better able to infect people who have received some vaccines. Booster programmes have been accelerated in many countries as a further dose, delivered recently, appears to offer greater protection. However, initial evidence also suggests that the severity of disease caused by Omicron is milder, resulting in shorter hospital stays. It is not clear if this is due to protection offered by prior infections and vaccinations or due to the mutations of the virus itself.

A lesser impact on hospital capacity could limit the degree of social intervention required, and support public health confidence. Both legally enforced social restrictions and public concern about coronavirus in the community weigh on the economy, especially social consumption. However, even where social restrictions are required, their economic impact shows signs of lessening. The social restrictions in place for much of the first quarter of 2021 were less damaging that the initial wave in 2020. On this basis, even if stringent social measures are introduced in 2022, the economic impact should be more moderate, delaying economic recovery rather than derailing it.

Question #2 – What will the fiscal response be?

While hospitalisation data hints that the Omicron variant could be a step towards the coronavirus becoming endemic, new variants remain a risk.

Through 2020 and 2021, social restrictions hindered sectors of the economy and employment, and governments responded by expanding fiscal spending. The bulk of expenditure went on supporting household incomes, via direct cheques, furlough schemes and extra unemployment benefits. In the US, a third stimulus cheque was delivered even as the economy was reopening. The result of this was a rapid economic recovery as households, on average, had avoided financial hardship and involuntarily amassed high savings they were willing to spend. Moreover, measures such as the UK furlough scheme have helped workers retain their jobs, which has prevented unemployment rising.

The question now is how willing governments will be to continue with income support measures if further social restrictions are required in 2022 and beyond. These measures have been costly and governments must consider how to navigate the transition towards the virus’ endemic phase.

Question #3 – Will the global vaccination effort get serious?

The emergence of Omicron is not a surprise given that globally less than 50% of people are fully vaccinated. On the continent of Africa, the Earth’s second most populous continent, only 13% have received a single dose. At the start of the pandemic, the shortage of vaccine doses caused price wars, international disputes and the rise of “vaccine nationalism”, leaving countries with fewer resources to negotiate agreements without enough supply.

International organisations have rallied to deliver equitable access to jabs. The Global Alliance for Vaccination and Immunisation established COVAX in 2020 to lobby on behalf of low and middle income countries. Despite meeting its funding requirements, GAVI’s progress has been hindered by difficulty in accessing doses, itself exacerbated by richer governments’ booster programmes drawing on limited supply.

The prevalence of mutations and the rapid decline in the protection offered by vaccines also means a pan-coronavirus vaccine must be a priority.

Question #4 – What choices will workers make?

The pandemic had a profound effect on the working lives of many, catalysing a shift toward working from home and remote work. The workforce has also undergone a transformation, with the labour force participation rate dropping sharply in developed countries like the US and the UK. This drop has contributed to the tightness seen in these labour markets. What remains unknown is why these workers have left the labour market and whether they will return. Some are likely to return - in the UK, many have pursued further study and are likely to seek employment once this is complete. However, the same may not be true for all workers, especially older workers. In the US, there is some evidence that the pandemic has exacerbated health concerns and childcare scarcity, and that these effects could fade if the health situation improves. If so, additional labour supply could ease the labour market, providing less support for wage growth. Given the important role of wage growth in supporting sustainable inflation, this could impact long-term inflation dynamics and, thus, monetary policy.

Question #5 – How will China’s policy evolve?

As the economic fluctuations caused by the ebb and flow of the pandemic show signs of moderating, Chinese policy re-emerges as a powerful driver of the global economy. Policymakers in Beijing appear to have gone back to 2018, resurrecting many of the measures interrupted by the US-China trade war, and then the pandemic. China’s leadership continues to target high-quality growth over high-rate growth at any cost. This means developing sophisticated technologies and its services sector, while de-emphasising its broad industrial sector. Policy makers are also strengthening regulation to promote data security, market competition, social equality and financial stability. Financial regulation has long had the highly-leveraged real estate sector in its sights, a key source of risk to the financial system. Combined, these policy areas are likely to weigh on global industrial demand in 2022, though China has been known to pull back from policies that begin to weigh on domestic growth. Whether Beijing will see through economic and regulatory reforms is an important question, second only to how relations with the US and EU evolve. Disagreements on technology and trade risk escalating into a more muscular dispute if they collide with the issues of China’s human rights record and Taiwanese independence.

 

What does this mean for investors?

Given the broader provision of testing and vaccines, coupled with the economy’s adaptation to social restrictions, we expect the negative impact on growth in 2022 to be limited.

Looking beyond health policy, fiscal decisions are crucial, especially at a time when global monetary policy is in tightening mode. These policy decisions matter most in the world’s two largest economies, the US and China. In the US, we anticipate the fiscal position remaining modestly supportive, with savings still boosted by last year’s stimulus cheques and infrastructure spending supporting growth and employment. The path of employment will determine the degree of tightening required and, though we expect rates to end the year higher, we do not expect them to be ‘high’ in an historical context. In China, policy makers already show signs of offsetting the negative impact of reform measures through the monetary channel, which may lend more support to credit growth in 2022 but the outlook is somewhat uncertain.

All in all, we expect this to create a more favourable environment for growth than we saw at the start of 2021, coupled with the prospect of higher interest rates. If a more stable health situation can end the dramatic variations seen in GDP over 2020-1, we can expect the economy to begin to return to normal growth levels, with long-term factors determining growth once more.

In this environment, equities continue to look more attractive than bonds, given that earnings are connected to the real economy. However, given the prospect of higher rates, we believe it is a time for vigilance where valuation is concerned, as this could put pressure on price-to-earnings multiples. While equities closely tied to economic growth may fare well in 2022, the shift to more stable growth and long-term GDP drivers should still support companies with structural growth advantages.

 

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