Financial markets are poised for a bumpy ride in 2022 in the face of soaring inflationary pressure, rising interest rates and ongoing disruption to international supply chains caused by the Omicron variant of coronavirus, experts have said.
Analysts and financial investors said Omicron’s emergence had raised the prospect of a stagflationary start to the new year, with weaker levels of economic growth despite intensifying price pressures in already stretched supply chains. The winter energy crisis will also weigh on Europe’s economies.
“Covid vaccines and treatments will take some of the edge off any social disruption we may face, and while many businesses have learned to trade through the stops and starts of the pandemic, a return of substantial winter restrictions [in the UK] and abroad would be a blow for the global economy,” said Laith Khalaf, the head of investment analysis at AJ Bell.
If the pandemic does ease in 2022 as hoped, central banks are expected to raise interest rates or cut back on their multitrillion-dollar quantitative easing bond-buying stimulus programmes to try to rein in inflation. The US Federal Reserve said this month that it anticipated raising borrowing costs three times in 2022, which could spook markets and weaken a recovery that is already expected to slow in 2022.
“High inflation has central banks feeling the heat, but by late 2022 we see a very different backdrop, with stagnation a bigger risk than stagflation,” said analysts at the Japanese bank Nomura.
Victor Golovtchenko, of the online broker Think Markets, said the US Fed was in the unenviable position of choosing between “persistently high inflation numbers, and persistently overvalued financial markets”.
Joost Beaumont, a senior fixed income strategist at the Dutch bank ABN Amro, said the coming year would be choppy for markets as a result. “We expect tighter global financial conditions, in particular from Fed rate hikes and rising US rates to again trigger bouts of volatility in markets.”
AJ Bell’s Khalaf said the bond market must face a day of reckoning eventually, unless monetary policy never normalises. “It might be a gradual deflation rather than an explosive rupture, but it does look like a question of when, not if. Long dated government bonds would be most in the firing line, so bond investors could seek to protect themselves by looking to shorter dated bonds, higher yielding markets, and strategic funds that employ a flexible approach,” Khalaf said.
The Bank of England is also expected to raise interest rates in 2022, perhaps two or three times, having unexpectedly lifted its main interest rate to 0.25% at its December meeting despite concerns over Omicron.
“In a very different modus operandi from the last pandemic resurgence, central banks are now on a firm tightening road,” said George Lagarias, the chief economist at Mazars. “We believe that for 2022, investors should at the very least be prepared for more volatility.”
Surging energy prices in Europe and Asia drove inflation higher this year, as supplies struggled to meet demand after the easing of lockdown measures over the summer across advanced economies. Inflation is expected to stay elevated in the short term but could then drop back through the year.
Bill Blain, a market strategist and the head of alternative assets at Shard Capital, said investors had not priced in the winter energy crisis that is driving up bills and forcing some factories to suspend work. “Markets are vastly underestimating just what higher power prices are going to do to corporate earnings and growth across the globe,” he said.
Europe is particularly vulnerable, while power outages and “industrial dislocation” in China could cause fresh supply chain chaos, Blain added.
High-growth but low-profitability tech stocks may fare badly in a world of higher inflation and rising interest rates. The share prices of many of those pandemic winners such as Zoom and Peloton have already fallen back from record highs in 2021. Paul Craig, a portfolio manager at Quilter Investors, said extreme growth-oriented stocks may continue to struggle.
“We are potentially witnessing the end of the valuation bubble in emerging startups, hyper-growth and companies wearing tech clothing, and it would not be a shock to see more pain going into 2022,” he said.
The US economy could stutter if Joe Biden does not get his $1.75tn (£1.31tn) Build Back Better legislation through the Senate, where the Democratic senator Joe Manchin is blocking the package.
A slowdown or worse in China could also jolt markets in 2022. “Despite Beijing’s recent shift in policy stance, we expect growth to weaken further in spring 2022 on a worsening property sector, rising costs of the zero-Covid strategy, an export downturn and widespread factory closures before and during the Winter Olympics,” said Nomura, which fears “the worst is yet to come”.
“We expect Beijing to take more decisive action to arrest the downward spiral in spring 2022, and growth could bottom out after that,” Nomura added.
Weaker growth in the world’s second largest economy could pull commodity prices down. Oxford Economics predict iron ore prices will end 2022 below current levels, while Beijing is expected to press its steel industries to curb greenhouse gas emissions.
Higher vaccination rates, particularly in emerging markets, will be crucial to fighting the pandemic and easing supply chain bottlenecks, said Seema Shah, the chief strategist at Principal Global Investors.
“In 2022, governments in emerging market [EM] countries accelerating the pace of vaccination should become more tolerant of Covid and ease strict containment policies. This means some Covid-driven activity surges for EM still lie ahead, providing a promising opportunity to extend the reopening trade. It also likely implies less frequent factory and port closures,” Shah said.
There is also the risk of geopolitical turmoil on the horizon; with Russian troops massing at the Ukraine border, increased tensions between Taiwan and China, and elections in the US and France.
Will Hobbs, the chief investment officer at Barclays Wealth and Investments, said: “The straits of Taiwan have been hotting up, as has Ukraine’s border with Russia. Right now, many will argue that the liberal democratic model is the one that looks a little more rickety. Upcoming elections will continue to be nervy affairs for a while yet – US midterms and French presidential elections are the ones to watch in 2022.”
Most Wall Street banks have forecast that equities will keep rising in 2022, adding to strong gains in 2020 and 2021.
Mark Haefele, the chief investment officer at UBS Global Wealth Management, has a positive outlook on stocks for the start of 2022. “Global economic growth is likely to remain above trend for the first half of 2022, monetary policy is still accommodative, even if emergency support measures are being scaled back, and we expect 10% growth in global corporate earnings in the year ahead,” he said.
But strategists at Bank of America predicted a slightly negative year, as “there are too many similarities between today and 1999-2000 to ignore.”
The UK still stands out as cheap and unloved compared with other markets, said Alex Wright, the portfolio manager of Fidelity’s special situations fund. That could mean further takeover action in the next 12 months, if overseas predators pounce on undervalued UK companies.
“UK equities remain significantly undervalued compared to global markets and reasonably valued in absolute terms. This has been reflected in a meaningful uptick in M&A activity, which has been a key contributor to performance for our funds. We are likely to see more bids if valuation discounts compared to overseas companies do not close,” he said.
But dangers abound as the new year approaches. “The three main risks lie in a policy mistake causing financial havoc, a disorderly energy transition seeing a surge in selected commodity prices, and a nasty variant escaping vaccine protection,” analysts at Generali Investments said.