The Covid years are riddled with predictions that didn’t work out. For anyone looking to 2022, that should be enough to pause.
Most forecasters, including Bloomberg Economics, have a strong recovery as a base case with a cooling in prices and a move away from emergency monetary policy scenarios. What can go wrong? Much.
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Omicron, sticky inflation, Fed take off, Evergrande crash in China, Taiwan, a race in emerging markets, hard Brexit, a new euro crisis, and rising food prices in a Tinder Middle East – all these items in a gallery of risky rogues.
Some things can also turn out better than expected, of course. Governments may decide to keep fiscal support in place. China’s latest five-year plan could catalyze stronger investment. Pandemic savings could finance a waste of global spending.
Omicron and more closures
It’s early for a final verdict on the Covid-19 omicron variant. Seemingly more contagious than its predecessors, it can also be less deadly. That would help the world return to something like pre-pandemic normalcy, which means spending more money on services. Covid lockdowns and caution have kept people out of gyms or restaurants, for example, and encouraged them to buy more stuff instead. A rebalancing of spending could boost global growth to 5.1% from Bloomberg Economics’ baseline forecast of 4.7%.
But we may not be so lucky. A more contagious and deadly variant would drag economies down. Even a three-month return to the tighter restrictions of 2021 (countries like the UK have already moved in that direction) could see slow 2022 growth at 4.2%.
In that scenario, demand would be weaker and global supply problems would likely persist, with workers out of labor markets and more logistical problems. Already this month, the Chinese city of Ningbo, home to one of the busiest ports in the world, has seen new closures.
The threat of inflation
In early 2021, the US was forecast to end the year with 2% inflation. Instead, it is close to 7%. In 2022, once again, the consensus expects inflation to end the year near target levels. Another major mistake is possible.
Omicron is just a potential cause. Wages, which are already rising rapidly in the United States, could rise further. Tensions between Russia and Ukraine could drive up gas prices. As climate change brings more disruptive weather events, food prices may continue to rise.
Not all risks go in the same direction. A new wave of the virus could affect travel, for example dragging down oil prices. Still, the combined shock could be a stagflationary shock that leaves the Fed and other central banks with no easy answers.
Driving Toward Fed Rate Hikes
Recent history, from the tantrum of 2013 to the stock sell-off of 2018, shows how a tightening of the Federal Reserve spells trouble for the markets.
This time, in addition to the risks, there are already high asset prices. The S&P 500 Index is close to bubble territory, and home prices drifting away from rents suggest that housing market risks are greater than at any time since the subprime crisis in 2007.
Bloomberg Economics modeled what happens if the Fed makes three hikes in 2022, noting that it will continue until rates hit 2.5%, raising Treasury yields and widening credit spreads. The result: a recession in early 2023.
Takeoff of the Fed and emerging markets
The Fed take off could spell a hard landing for emerging markets. Higher rates in the United States generally boost the dollar and trigger capital outflows, and sometimes currency crises, in developing economies.
Some are more vulnerable than others. In 2013 and 2018, Argentina, South Africa and Turkey suffered the most. Add Brazil and Egypt, call them BEASTS, for the list of five economies at risk in 2022, according to a variety of measures compiled by Bloomberg Economics.
Saudi Arabia, Russia and Taiwan, with little debt and strong current account balances, appear less exposed to capital flight in the emerging world.
China could crash into a great wall
In the third quarter of 2021, China’s economy came to a halt. The cumulative weight of Evergrande’s real estate recession, repeated Covid lockdowns and power shortages dragged annualized economic growth down to 0.8%, well below the 6% pace the world has become accustomed to.
While the energy crisis should subside in 2022, the other two problems may not. Beijing’s Covid Zero strategy could mean omicron lockdowns. And with weak demand and limited funding, property construction, which powers about 25% of China’s economy, may have to continue to decline.
The Bloomberg Economics baseline scenario is that China will grow 5.7% in 2022. A slowdown to 3% would create ripples around the world, leaving commodity exporters without buyers and possibly derailing the Fed’s plans, such as the fall in Chinese stocks did in 2015.
Political turmoil in Europe
Solidarity between leaders backing the European project and European Central Bank activism to keep government borrowing costs under control helped Europe weather the Covid crisis. In the next year, both could fade away.
A fight for the Italian presidency in January could topple the fragile coalition in Rome. France heads to the polls in April with President Emmanuel Macron facing challenges from the right. If Eurosceptics gain power in the bloc’s key economies, it could break the calm in European bond markets and deprive the ECB of the political support needed to respond.
Let’s say sovereign spreads widen by 300 basis points, as they did in the debt crisis of the last decade. Bloomberg Economics’ model shows that it could cut more than 4 percent of economic output by the end of 2022, driving the euro zone into a recession and rekindling concerns about its viability.
Feeling the impact of Brexit
Negotiations between the UK and the EU on the Northern Ireland Protocol, a doomed attempt to square the circle of an open land border and a closed customs union, will kick off in 2022. Getting there will be difficult.
What happens if the negotiations fail? According to the latest outbreaks of Brexit, the uncertainty would affect business investment and undermine the pound, driving inflation and eroding real income.
In an all-out trade war, tariffs and transportation jams could drive prices up even more.
The future of fiscal policy
Governments spent a lot to support workers and businesses during the pandemic. Many now want to tighten their belts. The decline in public spending in 2022 will amount to 2.5% of world GDP, about five times higher than the austerity measures that slowed recoveries after the 2008 crisis, according to UBS estimates.
There are exceptions. Japan’s new government has announced another record stimulus and Chinese officials have signaled a shift towards supporting the economy after a long period of pocket control.
In the United States, fiscal policy went from boosting the economy to slowing it down in the second quarter of 2021, according to the Brookings Institution. That will continue into next year, though President Joe Biden’s clean energy and child care investment plans will limit the drag if they make it through Congress.
Food prices and riots
Hunger is a historical driver of social unrest. A combination of the effects of Covid and bad weather has pushed world food prices to record highs and could keep them high next year.
The last food price shock in 2011 triggered a wave of popular protests, especially in the Middle East. Many countries in the region remain exposed.
Already under pressure, Sudan, Yemen and Lebanon all seem at least as vulnerable today as they were in 2011, and some are more so. Egypt is only marginally better.
Popular uprisings are rarely localized events. The risk of further regional instability is real.
Political, geo or local
Any escalation between mainland China and Taiwan, from blockade to outright invasion, could attract other world powers, including the United States.
A superpower war is the worst-case scenario, but scenarios below that include sanctions that would freeze ties between the world’s two largest economies and a collapse in Taiwan’s production of the semiconductors that are crucial to global production. of everything from smartphones to cars.
Elsewhere, Brazil is scheduled to hold elections in October, amid pandemic turbulence and a still depressed economy. Many things could go wrong, although a victory for a candidate who promises a tighter control of the public purse could bring some relief to reality.
In Turkey, the opposition is pushing to advance the elections from 2023 to next year amid a currency slide that is widely attributed to the unorthodox economic policies of President Recep Tayyip Erdogan.
What could go well in 2022?
Not all risks are negative. Budget policy in the United States, for example, could remain more expansionary than seems likely at the moment, keeping the economy off the edge of the fiscal cliff and fueling growth.
Globally, households have trillions of dollars in excess savings, thanks to the pandemic stimulus and frugality imposed during the shutdown. If it is spent faster than expected, growth will accelerate.
In China, investments in green energy and affordable housing, already envisaged in the country’s fourteenth five-year plan, could increase investment. Asia’s new trade deal, the Regional Comprehensive Economic Partnership, encompassing 2.3 billion people and 30% of global GDP, could boost exports.
In 2020, pandemic economies were worse than almost any economist had predicted. But that was not true in 2021: In many countries, recoveries were surprisingly fast. That’s a helpful reminder that some things could go well next year, too.
© 2021 Bloomberg