Financial markets are poised for a bumpy ride in 2022 in the face of soaring inflationary pressure, rising interest rates and ongoing disruption to international supply chains caused by the Omicron variant of coronavirus, experts have said.
Analysts and financial investors said Omicron’s emergence had raised the prospect of a stagflationary start to the new year, with weaker levels of economic growth despite intensifying price pressures in already stretched supply chains. The winter energy crisis will also weigh on Europe’s economies.
“Covid vaccines and treatments will take some of the edge off any social disruption we may face, and while many businesses have learned to trade through the stops and starts of the pandemic, a return of substantial winter restrictions [in the UK] and abroad would be a blow for the global economy,” said Laith Khalaf, the head of investment analysis at AJ Bell.
If the pandemic does ease in 2022 as hoped, central banks are expected to raise interest rates or cut back on their multitrillion-dollar quantitative easing bond-buying stimulus programmes to try to rein in inflation. The US Federal Reserve said this month that it anticipated raising borrowing costs three times in 2022, which could spook markets and weaken a recovery that is already expected to slow in 2022.
“High inflation has central banks feeling the heat, but by late 2022 we see a very different backdrop, with stagnation a bigger risk than stagflation,” said analysts at the Japanese bank Nomura.
Victor Golovtchenko, of the online broker Think Markets, said the US Fed was in the unenviable position of choosing between “persistently high inflation numbers, and persistently overvalued financial markets”.
Joost Beaumont, a senior fixed income strategist at the Dutch bank ABN Amro, said the coming year would be choppy for markets as a result. “We expect tighter global financial conditions, in particular from Fed rate hikes and rising US rates to again trigger bouts of volatility in markets.” AJ Bell’s Khalaf said the bond market must face a day of reckoning eventually, unless monetary policy never normalises. “It might be a gradual deflation rather than an explosive rupture, but it does look like a question of when, not if. Long dated government bonds would be most in the firing line, so bond investors could seek to protect themselves by looking to shorter dated bonds, higher yielding markets, and strategic funds that employ a flexible approach,” Khalaf said.
The Bank of England is also expected to raise interest rates in 2022, perhaps two or three times, having unexpectedly lifted its main interest rate to 0.25% at its December meeting despite concerns over Omicron.
“In a very different modus operandi from the last pandemic resurgence, central banks are now on a firm tightening road,” said George Lagarias, the chief economist at Mazars. “We believe that for 2022, investors should at the very least be prepared for more volatility.” Surging energy prices in Europe and Asia drove inflation higher this year, as supplies struggled to meet demand after the easing of lockdown measures over the summer across advanced economies. Inflation is expected to stay elevated in the short term but could then drop back through the year.
Bill Blain, a market strategist and the head of alternative assets at Shard Capital, said investors had not priced in the winter energy crisis that is driving up bills and forcing some factories to suspend work. “Markets are vastly underestimating just what higher power prices are going to do to corporate earnings and growth across the globe,” he said.
Europe is particularly vulnerable, while power outages and “industrial dislocation” in China could cause fresh supply chain chaos, Blain added.
High-growth but low-profitability tech stocks may fare badly in a world of higher inflation and rising interest rates. The share prices of many of those pandemic winners such as Zoom and Peloton have already fallen back from record highs in 2021. Paul Craig, a portfolio manager at Quilter Investors, said extreme growth-oriented stocks may continue to