Executive summary

A summary of our outlook for economies and markets.

Elevated inflation: Persistent, not permanent

As 2021 draws to a close, expectations are for global growth to be around six per cent for the year. That is broadly in line with our above consensus expectations at the start of the year and is despite the headwind to growth from the emergence of the Delta variant of COVID-19 in the middle of the year.

Among the major economies, the United States, United Kingdom and Canada all surprised us positively in 2021, while China, the Eurozone (primarily Germany) and Japan surprised on the downside.

Growth expected to moderate, but remain well above trend in 2022

The upside surprises largely reflected an even more buoyant consumer recovery than we had anticipated, supported by strong household income. The downside surprises reflected a combination of factors relating to COVID-19 management and global supply-chain issues that emerged over the course of 2021.

Looking ahead to 2022, we expect growth to moderate to around 4¼ per cent, broadly in line with consensus. Across all the major economies, we expect a slowing from the rapid pace of recovery in 2021, but a still above-trend pace of growth, reflecting the expected full reopening of the service sector, pent-up demand, strong household and corporate balance sheets and easy (albeit less so than in 2020/21) monetary and fiscal policy (Figure 1).

Figure 1. Major economy GDP growth projections
Figure 1. Major economy GDP growth projections
Source: Aviva Investors, Macrobond as at 1 December 2021

While much has been written about the build up of “excess” savings, particularly in those countries that provided extensive income support during periods of economic shutdown in 2020/21, and the capacity for that to sustain the recovery in household consumption, less has been written about the much larger increase in household net worth over the last two years.

For example, in the United States, net worth is estimated to have risen by over 20 per cent since the end of 2019, rising around three times faster than the average increase over the past 20 years. That equates to around $25 trillion, an order of magnitude greater than the estimated $2.5 trillion in excess savings. Moreover, the Federal Reserve estimates that the percentage gains in net worth across income quintiles has been similar. Comparable gains in household net worth are likely to have been experienced in other major economies.

Significant gains in household net worth support consumption growth

We expect the increase in net worth, alongside a strong rise in household income, to support consumption growth in 2022. Business capex is also expected to be solid in 2022, supported by strong profitability, excess demand across many sectors (especially manufacturing) and the need to increase capacity and inventories. While public sector deficits are set to decline materially in 2022 as various COVID-19 income support packages are removed, public sector investment should be supportive, as major infrastructure projects are undertaken to support the economic transition required by climate policy objectives.

Of course, risks remain to the outlook. In particular, the new Omicron variant of COVID-19 could present a challenge that may require (at least temporary) re-introduction of restrictions on economic activity. And it may not be the last variant that is a cause for concern, though we would expect Omicron or other variants to defer growth, rather than create a permanent loss, so long as income support measures were once again available. The risks around the growth outlook in China are also likely tilted to the downside, as the country continues to look to deleverage the property sector and pursue “common prosperity”.

The speed limit to growth that appeared in 2021 due to supply constraints, in the manufacturing sector in particular, should ease in 2022. We expect increased capacity and reduced economic restrictions should allow for production to pick up, with some recent evidence indicating an easing in the shortage of semi-conductor chips and an improvement in international shipping capacity.

However, the Omicron variant could have the potential to impact supply conditions should it require a forceful response. But even absent potential concerns around Omicron, we are focused on the already apparent tightness of labour markets around the world. While unemployment rates are still somewhat above their pre-COVID-19 level in the major economies, they are on a downward trajectory and other indicators, such as very elevated job vacancies, suggest that employers are finding it difficult to match potential employees to jobs (Figure 2). The tight labour market is also beginning to be reflected in rising wage growth, which in the United States is at a multi-decade high.

Figure 2. Number of unemployed per job vacancy at record low
Figure 2. Number of unemployed per job vacancy at record low
Source: Aviva Investors, Macrobond as at 1 December 2021

The combination of continued strong demand, tight labour markets and high consumer price pressures presents a challenging inflation outlook for 2022 (Figure 3). While the factors that have led to the sharp increase in inflation in 2021 are likely to abate in 2022 – notably the contribution from energy prices and consumer goods – these are likely to be met by rising underlying inflation pressures in the service sector. The first of those two effects is expected to dominate in 2022, with inflation likely to fall back from a peak in Q1, but the risk remains tilted for a less rapid decline.

We, like many other forecasters, have significantly revised up both the peak in inflation and the time we expect it to take to ease back. But given the uncertainties around the inflation process, and the unique nature of the recovery and expansion, it is right to be humble about the ability to forecast the inflation outlook with any certainty.

Figure 3. CPI inflation projections: taking longer to return to target in 2022
Figure 3. CPI inflation projections: taking longer to return to target in 2022
Source: Aviva Investors, Macrobond as at 1 December 2021

Looking beyond just the next 12 months, we think there are reasons to expect economic and financial market volatility to be higher over the coming years than it has in the past decade or more.

The economic shock that resulted from the COVID-19 pandemic was a seismic event. The forceful and coordinated fiscal and monetary policy response facilitated a rapid economic recovery. Indeed, the recovery has been so rapid that, as noted above, it created unexpected challenges to global supply-chains.

The COVID-19 shock has also coincided with a major review of monetary policy frameworks by several central banks. The frameworks were adjusted to allow economies to run ‘hotter’ in the cyclical upswings, in order to deliver a period of inflation above target when it has been preceded with a long period of below target inflation. It has also coincided with a more activist fiscal policy than we have seen for many decades.

While the impact of these changes on economic outcomes over the coming years is difficult to judge, it appears to present a mix of both economic opportunities and risks associated with COVID-19 itself, as well as a policy framework that is more willing to allow for greater variability in growth and inflation. Moreover, the economic transition needed to reduce dependence on fossil fuels adds to the potential economic uncertainty during that transition. These factors have arguably already combined to increase volatility in inflation (Figure 4).

Looking ahead, these factors could lead to a more sustained increase in both expected and realised economic volatility and which could also increase volatility and risk premia across asset classes. That could be particularly challenging for highly valued assets that have relied on zero interest rates and low volatility to justify those valuations. On the other hand, it could benefit high-quality, lower-valued assets that produce reliable free cash flow.

Figure 4. Realised US inflation volatility has risen sharply
Figure 4. Realised US inflation volatility has risen sharply
Source: Aviva Investors, Macrobond as at 1 December 2021

Reflecting on the new monetary policy frameworks, we see the Federal Reserve as already having let the economy run hotter than they would have in past cycles. Therefore, once they do move into the phase of removing policy accommodation, it could well come more quickly than in the last cycle.

Starting in mid-2022, we expect two to three rate increases by the end of next year, with another four to five in 2023. The Bank of England is expected to raise rates by a similar margin in 2022, although beginning that process sooner. Meanwhile, we now see the European Central Bank as potentially looking for a first rate increase in over a decade in early 2023. The Bank of Japan is not expected to raise rates in the next two years.

We retain a moderate overweight position to equities going into the new year (Figure 5). This is funded by an underweight position in credit. Equities typically fare better than credit during the middle stages of the business cycle, and whilst valuations are high for both asset classes, the prospect of rising rates volatility raises disproportionate downside risks to credit.

Figure 5. Asset allocation summary
Figure 5. Asset allocation summary
Source: Aviva Investors, Macrobond as at 1 December 2021

In light of persistently high inflation and risks to the inflation outlook being tilted to the upside, we maintain a negative stance on government bonds. Rate hikes may not only occur earlier and faster than the market currently anticipates but we also view terminal rates as underpriced. Moreover, should the Omicron variant temporarily impact growth negatively, the consequence for inflation beyond the near-term has the potential to turbo-charge the rates sell-off later in the year.

Emerging markets are expected to underperform developed markets in FX and in Equities. Headwinds for the EM complex include, but are not limited to, our expectation of slowing global economic growth momentum, monetary policy normalization and relatedly a risk of higher real rates, as well as a host of idiosyncratic risks ranging from politics to regulation, for which current valuations offer little room for error.

Read more of the House View

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Macro forecasts: charts and commentary

Our round-up of major economies; featuring charts and commentary.

Global market outlook and asset allocation

What our House View means for asset allocation and portfolio construction.

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