2022 starts with central banks more comfortable about lifting their foot from the accelerator
An exceptional confluence of events could lead to higher macroeconomic and financial market volatility in 2022, compared with the post 2007-2008 (Global Financial Crisis) era.
Specifically, inflation is running significantly higher than the long-run target of 2%, albeit central banks have remained patient, so far, due to, inter alia, their new operational frameworks. Note that advanced economies’ headline inflation has accelerated to 5.5% year-over-year in December, compared with an average of 1.4% from June 2009 to February 2020. At the same time, the GDP-weighted policy rate has been -0.1%.
Having said that, the minutes of the Federal Reserve’s latest meeting (released early January) suggested an increasing bias toward removing policy accommodation (i.e balance sheet reduction) sooner and faster relative to the 2014-2017 period, where Treasury and Agency MBSs reduction commenced 22 months after the first interest rate increase in December 2015.
Recall that the FOMC decided in December to end asset purchases by mid-March 2022 (three months earlier than initially expected), while the median FOMC official expects three interest rate hikes toward 1% by the end of 2022, from near zero currently.
Moreover, global supply chain disruptions persist and continue to put upward pressures on prices. According to New York Fed (Benigno et al, 2021), the Global Supply Chain Pressure Index suggests that disorders remain at historically high levels. On the positive side, movements in some components (containership rates have declined, ISM delivery times slowed in December but at a slower pace compared to November) suggest that capacity constraints are easing.
In addition, the emergence of new virus strains (Omicron) makes the economic outlook more uncertain, jeopardizing factory closures, particularly in Asia, due to zero-tolerance covid policies and exacerbating supply bottlenecks. Renewed mobility restrictions could delay the desired shift of consumer spending from goods to in-person services.
An overall positive tone prevailed for risky assets in 2021, albeit with elevated bond-market volatility Developed equity markets recorded double-digit returns as corporate earnings surged (MSCI: +20% in USD terms), with US overperforming. Emerging Markets declined (MSCI: -5% in USD terms) due to tighter regulation and growth deceleration in China. Speculative Grade corporate bond spreads narrowed by 76 bps (USD) and 24 (EUR), respectively, as, inter alia, default risks gradually declined.
Risk appetite entered 2022 on a negative note, as the surge in US Treasury yields (10-Year: +26 bps wow to 1.77%) due to hawkish Fed commentary acts as a double-edged sword that reduces the value of multi-asset portfolios, weighing simultaneously on growth-related segments of the equity market. Indeed, the US Russell 1000 Growth index (-4.8% wow) underperformed its Value peer (+0.75% wow) by the widest weekly margin (557 bps) since November 2020, as Technology (Nasdaq) recorded its largest weekly decline (-4.5%) since February 2021. On the other hand, Banks and Energy stocks (Value) overperformed.