2022 Global Economic Outlook
Macro insights: John Butler, Macro Strategist
Climate insights: Thomas Mucha, Geopolitical Strategist; Santiago Millán, CFA, Macro Strategist; Juhi Dhawan, PhD, Macro Strategist
Geopolitical insights: Thomas Mucha, Geopolitical Strategist
Views expressed are those of the authors and are subject to change. Other teams may hold different views and make different investment decisions. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional or institutional investors only.
Economic outlook for 2022: Reflation, but feeling like stagflation
Rapidly rising global inflation and slowing economic growth are likely to fuel fears of stagflation over the coming months. While initially it may feel like we are heading towards a scenario of high inflation and stagnating growth, we expect the recovery to continue in 2022, albeit at a slower pace and with stickier inflation.
As we look ahead to 2022, should investors fear a return to stagflation — the toxic mix of high inflation and low growth that blighted the global economy during much of the 1970s — or are the sharp price rises and the slowing of the recovery only temporary? We expect this debate to intensify over the next five to six months as high energy prices, supply bottlenecks and labour shortages take their toll. There is no doubt that the global recovery is already slowing, as evidenced by the evolution of our Global Cycle Index (Figure 1), which has started to move downwards and is likely to go lower over the next three to six months — we expect it to move to the level indicated by the blue dot. At the same time, we anticipate that global inflation, as measured by the MSCI World Price Index, will stay high given the rise in energy prices — which could accelerate in the event of a cold winter in the northern hemisphere — and persistent supply constraints. Elevated energy prices are also a negative for growth, as they erode confidence and squeeze real incomes.
Global inflation trends are changing
Crucially, we are now seeing a significant rise in core inflation, the inflation metric that excludes the more volatile food and energy sectors, across both developed and emerging markets. Figure 2 shows how core inflation across developed markets has broken out of the low ranges of the last 10 to 20 years. Today’s inflation also appears to be more volatile compared to the last 10 years. Following the global financial crisis (GFC), core inflation across developed markets was, on average, only slightly lower (0.15%) than the 10 years prior to 2007, despite the weakness in GDP, but it was much less volatile, reflecting the protracted nature of the post-GFC recovery. The current spike in global consumer price indices is primarily linked to supply-chain disruption and is therefore likely to be temporary. However, we think we are also about to witness a shift to a structurally higher inflation rate as a number of the key drivers that dampened inflation over the past 30 years, such as globalisation, supportive demographics and reduced price sensitivity to labour and energy costs, have gone into reverse. This means that inflation may once again become more responsive to cyclical factors and may therefore turn more volatile.
Too early to write off growth
However, looking through these negative headlines, we observe a steady decline in unemployment rates across developed economies and it is likely that unemployment will continue to decline as growth recovers in 2022.
In fact, our best guess is that by next year most developed economies will be back to pre-COVID trend levels from both a GDP growth and employment perspective, with core inflation at or above target. Supply is constrained but demand, particularly labour demand, is likely to remain firm. And although investors are now focused on rate rises, the reality is that central banks are still expanding their balance sheets into a negative supply shock, while governments debate how to loosen fiscal policy further. Nevertheless, higher and more volatile inflation could become a more permanent feature for the reasons outlined above, particularly if continued labour demand translates into higher wage growth.
Longer-term implications for markets
If this higher and more volatile inflation trend were to persist, central banks may find it harder to use extraordinary policy measures to counteract the threat of a new recession, in effect halting the paradigm that has existed since the GFC, where weaker growth was paraxodically good for risk assets as it forced central banks to provide additional liquidity, which then needed to find a home in asset markets. In fact, we are likely heading into a six-month window where growth slows but the liquidity injections are ending as the US Federal Reserve and other central banks taper. Markets will have to adjust to this more cycle-sensitive environment, but much will depend on the way central banks respond to stickier inflation. If they tighten too soon and too much, the cycle could turn over as consumers’ purchasing power is squeezed. Central banks would then have to intervene again, increasing the potential for negative rates, but that is not our base-case scenario.
On balance, still positive, but be mindful of the risks
In summary, we still expect a continued recovery of the global economy from the pandemic shock, facilitated by ongoing monetary and fiscal support, despite what is likely to be a rocky growth patch over the next six months. At times, it may feel that we are sliding towards stagflation. However, the main risk to our economic outlook is not so much stagflation but the potential for a recession triggered by premature central bank tightening, persistent supply constraints and/or a more serious slowdown in China. While these risks have increased, it has not changed our underlying view that growth will continue to recover in 2022, as households run down the savings they accumulated during the pandemic, corporates invest and policy — particularly fiscal policy — remains supportive.
After the inflection point: How the climate challenge will transform the global economy
Wellington’s Central Macro Team believes climate change is an emerging megatrend that will reshape the global economy and that we will be studying from a variety of perspectives in 2022 and for many years to come. Recent headlines — from deadly flooding in China and Germany to historic wildfires and hurricanes in the US — are adding momentum to the trend.
From a policy perspective, political leaders and societies around the world have made up their minds: The time has come to begin the long, complex process of decarbonizing the economy. While that much is clear, we believe the significance of this macro inflection point, which will lead to massive changes in infrastructure spending, regulation, and geopolitical dynamics, is underappreciated. It will be decades before we know whether the ultimate objectives of decarbonization are realized, but in the meantime, investors should expect climate change to have ever larger and more material effects on economic growth, the cost of capital, and the performance of a vast range of companies and industries.
In this note, we outline the conclusions from a joint research project that our team, working closely with Wellington’s Climate Research Team, conducted on the global, regional, and geopolitical implications of reshaping the world’s economic framework for a lower-carbon future.
The road to economic disruption
Looking across our areas of coverage, we see three broad drivers of economic disruption emerging as the efforts to address climate change intensify:
The economic response to climate change will require spending across the public and private sectors in all countries. Public infrastructure spending will change and accelerate, potentially boosting overall investment spending by 1% – 2% of GDP. Increased government spending and incentives, along with changing consumer preferences, should, in turn, spur more private sector spending on innovation and new technology. Figure 1 highlights specific areas of spending focused on mitigating the effects of climate change and adapting to those that can’t be avoided.
2. Green finance and regulation
Finance is changing, and over time all finance will be green. The cost of capital will increase or decrease depending on a company’s position on the carbon spectrum. Carbon markets will be directly investable and a significant new financial market whose price will be material to future outcomes for many companies.
We’re already seeing the effects on access to capital at the company and project level, and these trends will only intensify. Europe and China are moving in this direction most rapidly, but it will be an important factor in the US as well — particularly at the state and local level where there are many initiatives already being launched to foster the roles of a green financial system (i.e., enhancing the return on green investments, reducing the returns on polluting investments, and increasing investor/consumer preference for green choices).
3. Geopolitical factors
Climate change will trigger resource conflicts and migration globally, while destabilizing countries and regions, particularly in equatorial and nearby areas that are home to many emerging markets and geopolitical hotspots. Over time, the national security narrative and the climate policy narrative will become more intertwined, with a variety of macro and market implications. Growing resource scarcity, for example, will inevitably drive conflict and raise defense spending. On the other hand, adaptive solutions to climate change like those highlighted in Figure 1 may help to prevent mass climate migration and the accompanying political stress. (Read more on climate change as a national security threat.)
A brief survey of our regional views
There is strong policy momentum in the US, Europe, and China. But of course the specific commitments, policy initiatives, and potential outcomes vary.
US — Climate change is a top priority for the Biden administration, whose goals include net-zero carbon emissions by 2050 and a carbon-free power sector by 2035. The levers to achieve these goals will include increased investment in sustainable and eco-friendly infrastructure (part of a broader US infrastructure revival discussed here), as well as tougher environmental regulations. The infrastructure proposals, including the climate-related initiatives, could provide a lift in economic growth of 50 bps – 75 bps over the next few years, putting some upward pressure on interest rates. There are risks, as well. For example, the plans mark another step up in federal spending that could contribute to somewhat higher inflation. Read more on the US outlook here.
Europe — The European Union (EU) joined others in committing to net-zero carbon emissions by 2050, but didn’t stop there, announcing that it would also reduce emissions more aggressively up front — by 55% from 1990 levels by 2030. In agreeing to a new budget framework for 2021 – 2027 and to the Next Generation EU package, EU leaders committed to focusing 30% of spending on climate‐related projects. These commitments are, at least currently, strongly backed by the electorates. Europe will also substantially increase prices/taxes on carbon, reshaping economic incentives and triggering large declines in carbon-intensive capex and spending, while driving up clean spending. Read more on the European and developed market outlook here.
China — China announced a target of zero net emissions by 2060 and brought forward its peak emissions date to before 2030. The peak emissions pledge was not a surprise, as the rate of decarbonization is already at or above the rate of economic growth. The net-zero carbon commitment, however, will require an overhaul of the entire economic structure. The Chinese government plans to tackle this challenge by reworking the national energy structure and increasing energy efficiency; establishing a carbon price and developing a Green Financial System; adopting a framework for environmentally sustainable economic activities; and investing in mitigation, adaptation, and innovation solutions. Read more on the outlook for China here.
A few thoughts on other emerging markets
There is great diversity in the energy mix of different emerging markets, with some having broad access to renewables while others have no choice but to burn oil and coal. These and other circumstances will determine the choices and constraints these countries face in addressing climate change. Multilateral institutions like the World Bank are already considering climate issues in dealing with sovereign debt restructurings, grants, and other types of subsidized lending. And international cooperation will be essential to help incentivize countries to take actions that sometimes can be very expensive in terms of money and opportunity cost.
It seems clear that emerging markets are generally more vulnerable than developed markets given their geographical position, capital stock, the internal distribution of their populations, and the types of economic activity that are dominant. This is unlikely to incentivize mitigation spending but could significantly raise the need for (and return to) adaptation spending.
The economic big picture
In coming years, the response to climate change, on both the spending and regulatory fronts, will dramatically reshape economic and market outcomes in a way that investors cannot afford to ignore. Globally speaking, we would expect the impact on GDP and employment over the next decade to be positive, dominated by the rise in capital expenditures. In the longer term, we would prepare for higher energy prices to depress energy-intensive capital expenditures and consumption.
The sustained rise in spending we’ve described will have strong multiplier effects, lifting investment and income in the global economy. Climate-related geopolitical disruptions will further pressure great-power competition in a variety of regions. Finally, even as the world moves forward with decarbonization, the required infrastructure rebuild will initially (perhaps over the first decade) drive demand for oil higher — and inflation with it. Longer-term, rising energy/carbon prices will also have a sustained, direct impact on inflation. That should lead to higher real and nominal interest rates.
Geopolitics in 2022: Turbulence ahead?
In my view, 2022 will present one of the most complex, unpredictable, and potentially dangerous geopolitical backdrops in decades.
Several factors drive this elevated risk, starting with structural changes in the geopolitical environment that include a more competitive world order, rising economic inequality, and political dysfunction globally. We are also witnessing the growing national security implications of climate change.
I believe that COVID-19 will still have a lingering impact. As we saw in 2021, the pandemic tends to accelerate geopolitical shifts and help shape events in new and surprising ways by contributing to diverging macro effects, ongoing supply-chain disruptions, cyclical and structural changes in labor markets, and varying inflation outlooks. Expect all this macroeconomic uncertainty to influence, once again, domestic policies and elections.
US-China policy: Great-power competition, writ large
Given the stakes for the global economy and investors, the US-China relationship will arguably remain the most important geopolitical dynamic in 2022.
While both governments will likely prioritize domestic matters — COVID-19 management, the Winter Olympics in Beijing, the Chinese Communist Party’s 20th National Party Congress, US mid-term elections — we can expect intensifying great-power competition to dominate the geopolitical backdrop in 2022, and for years to come.
I anticipate that the US will look to deepen multilateral security approaches in the Indo-Pacific, such as the Quad security alliance with Japan, Australia, and India. This new foreign policy direction also includes Australia’s plans to acquire advanced US nuclear submarine technology under the emerging AUKUS security alliance, as Canberra effectively joins the US “special relationship” with the UK.
These significant security developments in the Indo-Pacific come amid US intelligence reports that China is rapidly upgrading its nuclear weapons arsenal and hypersonic missile capabilities.
I also think that the great-power competition will trigger new legislative initiatives on Capitol Hill in 2022, as US lawmakers seek new tools to counter China’s military and economic rise.
Here, we should look for more US government support and attention for “strategic” industries, including semiconductors, space technologies, next-generation communications, robotics, biotech, rare earth minerals, artificial intelligence, and quantum computing.
Beijing, meanwhile, is likely to continue to advance its own expanding military, economic, and diplomatic capacities in 2022, as China seeks greater regional and global influence.
With geopolitical rivalry forecast to grow in importance in 2022, both countries will remain keen to “decouple” strategic sectors in a managed fashion, while also seeking opportunities for limited bilateral cooperation in areas of mutual interest including trade, climate, and the global pandemic.
Key geopolitical risks: What could go wrong?
Several geopolitical risks could derail my base case of a structurally challenged but more “manageable” US-China relationship in 2022. In a worst-case scenario, any one of these could lead to a sudden rupture in bilateral relations.
Taiwan tops this list, given its strategic and domestic political importance to Beijing, and the emphasis on human rights and democracy in the Biden administration’s foreign policy.
It is probable, therefore, that tensions will stay elevated in and around the Taiwan Strait, with a higher tempo of military activity on all sides presenting a low but real risk of accidental military conflict.
Driven by territorial disputes and increased military activity, geopolitical risk is also likely to remain pronounced in the South and East China Seas, while North Korea’s accelerating nuclear weapons program could produce additional opportunities for crisis and conflict in 2022.
Elsewhere, I see Iran as another crucial geopolitical risk to monitor — particularly if ongoing diplomatic efforts to resuscitate the Joint Comprehensive Plan of Action (JCPOA) fail, and Tehran resumes its nuclear program.
Meanwhile, cyber risks may intensify in 2022 for both government and corporates, as this highly effective (and highly disruptive) “shadow war” tool becomes the new normal in a more competitive global order.
As for Europe, Russia’s role in the great-power competition will continue to be the chief concern of the US and its allies, particularly as Moscow advances its hypersonic and nuclear weapons capabilities. I also expect more Russia-linked cyber operations aimed at US and Western companies, as part of the “new normal” of geopolitical risk.
On the horizon: Climate change as geopolitical risk
Finally, I expect climate change to become a bigger defense priority in 2022.
Natural disasters around the world have underscored the Pentagon’s long-standing concerns about the national security implications of climate change, which it views as a “complex catastrophe” that will act as a threat multiplier across many dimensions.
These coming climate risks will be centered on equatorial regions and in the tropics — home to some of the world’s most challenging geopolitical hotspots, as illustrated in Figure 1. Principal threats include increased climate migration, resource conflicts, food and energy shortages, rising extremism, and expanding opportunities for disease vectors.
At the same time, climate change is likely to continue to pressure US military capacity in 2022, just as it is likely to further destabilize the geopolitical backdrop.
As it stands, more than two-thirds of US military facilities have already been hit by climate-related events such as wildfires, heat waves, hurricanes, and flooding. This includes the critical US national security assets of Norfolk Naval Station in Virginia (also home to more than 30 other military installations), Marine Corps Base Camp Lejeune in North Carolina, and Tyndall Air Force Base in Florida.
The Pentagon has also reported a 60% increase in heat-related illnesses among troops over the past decade, adding to heightening national security concerns.
I expect that this “climate as national security” argument will continue to shape the US climate policy narrative in 2022 — and for years to come — as it merges with the long-term trend of great-power competition.
Investment implications: Adapt, adapt, adapt
Great-power competition and climate change issues that intensify in 2022 may present significant long-term investment opportunities as governments, businesses, and individuals across society seek to adapt to these structural geopolitical shifts.
Major investment themes related to great-power competition include strong demand tailwinds for traditional defense applications, with a particular focus on emerging “dual-use” technologies that have both civil and military applications, as these are now at the heart of shifting military doctrines in the US, China, and globally.
On the climate side, I view adaptation as the most direct way to invest through the geopolitical lens, as helping societies better cope with rising temperatures, food and water scarcity, flooding, storms, and other climate-related issues will be the best insurance policy against these coming national security challenges.
about the authors
Macro Strategist, London
As the investment team leader of the firm’s Global Macro Strategy effort and a member of the Global Bond Team, John leads our global macroeconomic strategy efforts and contributes to the management of global portfolios for the firm’s clients around the world. He focuses on macro forecasting & analysis and monetary policy for the UK and Europe, as well as the global cycle, translating key macro data into investable ideas and themes and working closely with investors around the firm.
Geopolitical Strategist, Boston
As a member of the firm’s Global Macro Strategy Group, Thomas conducts research on the macro and market implications of geopolitical risk. In his role, he also focuses on internal and external communication efforts, with a particular emphasis on connecting our macro insights to actionable investment ideas in client portfolios.
Santiago Millán, CFA
As a member of the firm’s Global Macro Strategy Group, Santiago leads our efforts in thematic analysis and sector-based macro research for China and other Asian countries. He is an active participant in investment strategy groups focusing on both debt and equity markets, and he provides valuable insights to portfolio managers and analysts around the firm as he translates macro data into investable ideas and themes.
Juhi Dhawan, PhD
As a member of the firm’s Global Macro Strategy Group, Juhi leads our efforts in equity sector-based macro and profits research for the US and also focuses on thematic research. She is an active participant in investment strategy groups, and works closely with investors across the firm to translate her work into investable ideas and themes.
This is an excerpt from our 2022 Investment Outlook, in which specialists from across our investment platform share insights on the economic and market forces that we expect to influence portfolios in the year to come.