By Tiffany Wilding, US Economist, Tony Crescenzi, Portfolio Manager and Andrew Balls, CIO of Global Fixed Income at PIMCO.
Over the past year, much of the global economy transitioned quickly from an early cycle recovery to a mid-cycle expansion, and uncertainty has become an ongoing theme in markets, economies, and communities.
In our January 2022 Cyclical Outlook, “Investing in a Fast-Moving Cycle,” we discuss key trends across global economies, policies, and investment sectors that inform our outlook for the coming year along with high-level portfolio strategy. This blog post summarizes our views.
Economic outlook: More volatility, more uncertainty
The robust global recovery continued in 2021, although unevenly across regions and sectors. Overall, government policies to support demand amid one of the largest economic contractions in modern history produced one of the fastest recoveries. This trend aligns with our long-term outlook for a more uncertain and volatile macro environment with economic cycles becoming shorter in duration, larger in amplitude, and more divergent across countries.
With the largest economic effects of the pandemic likely in the rearview mirror, peak policy support, and therefore peak real GDP growth, was also likely realized in 2021. We expect developed market (DM) GDP growth to decelerate from a 5.0% annual average pace in 2021 to 4.0% in 2022.
The speed of the economic recovery coupled with the volatile path of the virus have contributed to more significant frictions in both goods and labor markets that have elevated inflation. We expect DM inflation to eventually moderate back toward the respective central bank targets by the end of 2022, but only after peaking at 5.1% in 4Q 2021.
As a result of the magnitude and the persistence of the recent inflation overshoot, we also now expect an earlier start of DM central bank rate hiking cycles and raised our expectations for the likely level of terminal rates in many emerging market (EM) economies.
In summary, the broad contours of our 2022 outlook include above-trend (albeit slowing) growth and moderating inflation prompting a still gradual tightening in DM monetary conditions. Nevertheless, we see three important risks to our base case, which create a generally more uncertain environment for investors. These include the possibility of persistently elevated inflation, virus variants that drive surges in COVID-19, and the potential for financial conditions to tighten more abruptly than expected.
Despite those risks, markets appear priced for a blue sky scenario where central banks achieve the elusive soft landing without any meaningful amount of rate hikes. Yet, history reminds us that sometimes “stuff happens” when monetary policy pivots.
Risk premiums and yields don’t reflect potential downside scenarios, in our view, which warrants caution and a rigorous approach to portfolio construction.