The Fed chair has spoken … markets are adjusting. Outlooks which were only recently concocted, are being revised with newly accelerated tapering / HIKE timing and strategists mark themselves to market so at some point (in not so distant future) then can tell us all they told us so.
This morning’s economics brief from BBG:
In August 2020, the U.S. Federal Reserve — high priests of the global economic system — unveiled a new framework designed to combat what its leaders thought would be a world of persistently low unemployment and even lower inflation. At the end of 2021, they find themselves facing a world of high inflation and falling unemployment that their policy regime is ill-suited to address.
That mismatch between expectations and outcome is emblematic of a pandemic that has underscored the limitations of economic foresight. At the start of 2021, no one anticipated that U.S. inflation would end the year above 6%. Few foresaw that trillions in excess savings would, in addition to supporting robust consumer demand, also enable workers to stay out of the labor market, reducing supply. No one except the perma-bears — now joyfully lumbering out of their caves — anticipated China’s Evergrande slump.
As we venture forecasts for 2022 and beyond, then, it’s with a fair dose of humility and an even larger helping of caveats. A world where the omicron variant illustrates the virus’s continued ability to surprise, where the Fed and other central banks are facing a level of inflation not seen in three decades, and where China’s policy makers are attempting to deflate a McMansion-size real estate bubble is not one where crystal balls are unclouded.
That said, after the tribulations of 2021, our base case is that 2022 brings the beginning of a return to normality. For the U.S. and other advanced economies, with spare capacity remaining but the initial reopening surge over, the pace of growth is set to moderate toward potential. Among emerging markets, the slowdown in China — dragged down by the property slump — will be the dominant factor. Pull the pieces together, and we see global growth at 4.7%, down from 6.4% in 2021 and on a path to 3.5% in 2023.
On inflation, the panic about rising prices is, in our view, both entirely understandable and soon to be over. Outsize price gains in 2021 have been driven — in large part — by the combination of a low base effect, high energy prices, snarled logistics, and stimulus-fueled demand. By the middle of 2022, the base effect will be gone, logistics should be operating more smoothly, the stimulus boost will be fading, and energy prices would have to rise a lot from already elevated levels to maintain the same inflationary impetus.
Within that global narrative, though, there are differences that will put major central banks on divergent paths. In the U.S., inflation is running hotter and — with rising wages an additional driver — has more risk of staying above target. We now think that the Fed will accelerate the pace of taper, opening the possibility of a rate hike as early as March if inflation stays high. In the euro area, in contrast, we think inflation is set to fall back to 1% and market expectations that the ECB will liftoff in 2022 will be frustrated.
Also worth noting: 2022 will likely see the People’s Bank of China moving in the opposite direction as the Fed. We see China’s central bank cutting the loan prime rate by 20 basis points, in addition to multiple cuts to the reserve requirement ratio, even as the Fed begins to normalize policy. A yuan that’s closer to fair value, and moved more by the market than policy controls, has enabled the PBOC to escape the impossible trinity and chart its own course. With China facing multiple headwinds to growth, additional space to stimulate is welcome.
And … the (bond)beat goes on…