Economy  

Inflation will remain the dominant question for markets in 2022

Inflation will remain the dominant question for markets in 2022

2021 was a year of transition, from the heady stimulus of 2020 to a less accommodative stance as central banks and governments sought to gradually moderate the earlier levels of pandemic support.

2021 also saw the debate rage between the transitory and sustained inflation camps with no side decisively prevailing, but driving plenty of swings within equity markets in the interim.

Against that context, 2022 may be the year where one of the two big investment styles of value vs growth begins to become dominant. Below I outline three big areas to watch that could help investors navigate the markets in 2022.

Policy normalisation

Over the past few months, central banks have been increasingly keen to remove some of the accommodation provided during the pandemic.

Markets have been myopically focused on when the major central banks will announce their first rate rise, so called ‘lift-off’. Arguably, the timing of the first rate rise is far less relevant than the absolute level of interest rates, which is what really drives bond markets and capital allocation within the economy.

We do not expect a rapid sequence of additional rate increases, and as such we expect interest rates to remain low against historical ranges throughout 2022, and indeed for some time to come thereafter. Governments have also been faced with huge bills for their accommodation during the pandemic, and while there are different approaches to how to deal with this (higher taxes or reducing spending), there is likely to be some inevitable ‘fiscal drag’ as the furlough schemes and support programmes have rolled off.

What this means is that 2022 will see a less supportive backdrop in terms of monetary and fiscal policy but we expect governments and central banks to be cautious of too rapid a normalisation, in case it snuffs out the continued economic recovery.

This less supportive backdrop could pose challenges for government bond yields and increases the importance of corporate earnings, which need to continue to deliver to justify current valuations.

The pandemic

With the end of 2021 seeing the rise of the Omicron variant and associated reintroduction of restrictions to fight the new variant, investors have dusted off their charts showing Covid-19 cases and paid more attention to the day-by-day government response. Whilst new variants pose unknown challenges, initial data show that vaccines are still effective against the latest iteration.

We expect vaccines to continue to break the chain between infection and serious illness and therefore for 2022 to look quite different to 2021. That said, progress on the vaccines and the pandemic are key for cyclical sectors and equities more broadly, which abhor the information vacuum that is created when conditions rapidly change.

Inflation

Inflation remains the dominant question for markets. In the short-term, prices have clearly been heavily distorted by consumers switching from services to goods during the pandemic.

Over the course of 2022 we expect this imbalance to start to correct and for inflationary pressures to ultimately moderate as economies more effectively respond to supply-chain bottlenecks and base effects ease.