Central banks across the globe will have "no margin for error" in deciding whether to increase interest rates during 2022, according to Rathbones's chief investment officer.
Ed Smith told FTAdviser the monetary policy outlook for the next year was uncertain.
He said: "While the Fed has announced – and may accelerate – the tapering of bond purchases, it appears to be raising the bar for hiking rates.
“Meanwhile, the ECB is also adamant that interest rates will stay low next year.
“Nevertheless, interest rate derivatives still suggest that the Fed will hike twice next year, that the Bank of England will hike four times, and even the ECB will hike once.”
All these paths seemed unlikely, he said, given current central bank rhetoric and a reassessment could push shorter-maturity bond yields down if inflation does recede.
If inflationary pressure dissipates, the pressure on central banks to hike rates would ease, enabling continued support of the recovery, he said.
“However, if further virus waves cause the dislocations that have driven inflation higher to persist, central banks may have to hike rates to control inflation while economies struggle.
“This is the catch-22 for 2022 with no margin for error, and hiking rates at this point eventually may be viewed in the same way as the ECB’s ‘mistake’ hikes in 2008 and 2011 that required quick reversals.”
Smith warned equity returns will probably be less spectacular than in 2021.
“This is because higher valuations globally may make equities, particularly the most growth orientated, more susceptible to rising rates; while high margins (especially in the US) could face pressure from rising interest costs and taxes."
Smith said that before the virus’s most recent wave, growth in leading indicators such as the PMI surveys had been slowing across many regions but remained at good levels a long way from contraction.
“Moderating growth, modest equity and bond returns plus continued inflation, rates and coronavirus uncertainty all mean correlations and volatility in markets could be talking points again in 2022,” he said.
“This makes a balanced portfolio containing both defensive and growth stocks alongside cyclical and value ones prudent and makes diversification through exposure to non-correlated strategies and gold more important.”
Smith added there was also uncertainty over the outlook for longer-maturity yields due to inflation risks, the impact of tapering quantitative easing, and the prospect of less bond issuance in 2022 due to reduced fiscal stimulus.
“That said, improving economic conditions, inflation and tapering are all consistent with nominal and real yields moving modestly higher next year, with current low yields and tight spreads also suggesting limited return potential from government and corporate bonds. In other words, the yield curve may steepen.
“With PMIs resilient and supply-chain issues to unwind, earnings growth should stay robust. Indeed, our above-trend estimate of 2022’s global GDP growth is consistent with a rate of global profit growth above the 7-8 per cent currently pencilled in by analysts.”
sally.hickey@ft.com
