The dark clouds hanging over 2022 may not be benign


Despite the declines and disruptions from new covid variants, 2021 has turned out to be a relatively positive year for economies and markets in most parts of the world. Growth exceeded its potential after the 2020 recession and financial markets recovered vigorously. This was particularly the case in the United States, where stock markets have reached new highs, in part due to the ultra-accommodative monetary policy of the US Fed, followed by central banks of other advanced economies. But 2022 could be more difficult. The pandemic is not over. Omicron may not be as virulent as previous variants, but it is much more contagious, which means there can still be a high number of hospitalizations and deaths. The resulting uncertainty and risk aversion will suppress demand and disrupt supply chains.

Combined with excess savings, pent-up demand, and relaxed monetary and fiscal policies, supply bottlenecks fueled inflation in 2021. Many central bankers who insisted that the Inflationary surge was transient now have admitted that it would persist. With varying degrees of urgency, they plan to phase out unconventional monetary policies such as quantitative easing, so that they can begin to normalize interest rates. Their resolve will be tested if key rate hikes cause shocks to the bond, credit and equity markets. With such a massive build-up of private and public debt, markets might not be able to digest higher borrowing costs. In a crisis, central banks would find themselves in the debt trap and could back down. This could make inflation rampant.

This year could also see increased geopolitical and systemic risks. On the first front, there are three major threats to watch out for.

First, Russia appears poised to invade Ukraine, and it is not clear whether negotiations on a new regional security regime can prevent this threat from escalating. Although US President Joe Biden has pledged more military aid to Ukraine and threatened tougher sanctions against Russia, he has also made it clear that the United States will not intervene directly to defend Ukraine. But the Russian economy has become more resilient to sanctions than it was, so threats like that might not deter Moscow. After all, some Western sanctions, such as a move to block the Nord Stream 2 pipeline, could even exacerbate Europe’s own energy shortages.

Second, the Sino-US cold war is cooling off. China is increasing its military pressure on Taiwan and in the South China Sea, and the wider decoupling between the Chinese and American economies is accelerating. This development will have stagflationary consequences over time.

Third, Iran is now a nuclear state on the threshold. He enriched uranium to a quasi-military grade, and negotiations on a revised nuclear pact came to naught. Israel is considering strikes against Iranian nuclear facilities. If that happened, the results of stagflation would likely be worse than the oil-related geopolitical shocks of 1973 and 1979.

Next, consider the systemic concerns. In 2021, heat waves, fires, droughts, hurricanes, floods, typhoons and other disasters have laid bare the implications of climate change. The CoP-26 climate summit offered mostly low-cost talks, leaving the world on track to experience a devastating 3 ° Celsius warming in this century. Droughts are already causing soaring food prices and the other effects of climate change will worsen. In addition, the pressure to decarbonise economies leads to underinvestment in fossil fuel capacity before there is a sufficient supply of renewable energy. This dynamic will generate higher energy prices over time. In addition, the flow of climate refugees to the United States, Europe and other advanced economies will increase just as these countries close their borders.

Meanwhile, political dysfunctions are growing in both advanced economies and emerging markets. The midterm elections in the United States may offer a glimpse into the widespread constitutional crisis that could follow the United States presidential election in 2024. The United States has experienced almost unprecedented levels of partisan polarization, political deadlock, and radicalization, all of which pose a serious systemic problem. risk.

Far-right and far-left populist parties are gaining strength around the world, even in regions like Latin America, where populism has a disastrous history. Peru and Chile both elected radical left leaders in 2021, Brazil and Colombia could follow suit in 2022, and Argentina and Venezuela will remain on the path to financial ruin. The normalization of interest rates by the major central banks could cause financial shocks in these emerging markets and other fragile ones like Turkey and Lebanon, not to mention the many developing countries with low debt ratios.

Financial markets remain sparkling, even bubbling. Both public and private capital are expensive (with above average price / earnings ratios); real estate prices are high in the United States and many other economies; and there is still a buzz around meme stocks, crypto assets, and SPACs (special purpose acquisition companies). Government bond yields remain ultra-low and credit spreads, for both high yield and investment grade bonds, have been squeezed, in part thanks to direct and indirect support from central banks.

As long as the central banks were in unconventional political mode, the party could continue. But global asset and credit bubbles could deflate in 2022 once policy normalization begins. In addition, inflation, slower growth, and geopolitical and systemic risks could create the conditions for a market correction in 2022. Either way, investors should remain on the edge of their seats during the most of this year. © 2022 / Project union

Nouriel Roubini is CEO of Roubini Macro Associates and co-founder of TheBoomBust.com

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