In our previous article published at the end of November, we projected 2022 would be the year of normalisation, with the gradual return of the world economy to reality.
Our view was that after a sharp slump in 2020 and an overshoot in 2021, economic growth in developed markets would begin to slow down in 2022, while growth in emerging markets, excluding China, would recover. The reopening of many emerging-market countries after massive vaccination campaigns would be the key to economic revival.
But in just the past month, the macroeconomic backdrop has shifted massively, with two new factors that make predictions more difficult. They are the rapid spread of the Omicron coronavirus variant, and rising inflation risk that is causing the US Federal Reserve to speed up the tapering of its stimulus measures and start raising interest rates.
Because Omicron has been shown to spread far more quickly than the Delta coronavirus variant, several countries have begun reimposing travel restrictions or, in the case of Thailand, reviving quarantine regimes. But preliminary research shows infected people don't show symptoms as severe as with Delta, which has offered some hope.
In addition, vaccine makers such as Pfizer say a third or booster shot would increase the effectiveness of protection against Omicron. This brought investors some level of relief and they remained in risk-on mode in early December.
BOOSTER DATA WEAK
But if we dig deeper into the details, we think some caution is in order, as preliminary studies suggest the efficacy of the booster dose is not very high -- around 58% a few weeks after vaccination -- and tends to declines substantially (25-40 times) over a period of 2-3 months.
The very rapid rise in Covid cases, especially in Europe, is also cause for concern. The UK is now reporting more than 100,000 new cases daily, with about 50% of them Omicron. In the US, 75% of the 260,000 daily infections are from Omicron. And even though the latest UK research says people with Omicron are 70% less likely to be admitted to hospital than those with Delta, other European countries have begun banning travellers from the UK. Some have imposed lockdowns and are bracing for a spike in infections after the New Year festive holiday.
Turning to the second factor, the US consumer price index in November was the highest in 39 years, while the core personal consumption expenditure index -- the Fed's preferred gauge -- was also the highest since 1982. The two indices cover a variety of components, both on the supply side, such as energy, food, clothing and medicine, and on the demand side such as rent and wages.
This has prompted the Fed to speed up the tapering of its quantitative easing -- currently it is buying $90 billion worth of assets a month -- with a view to ending it in March. This would pave the way for interest rates to rise for the first time since 2018.
In our view, inflation over the next three to six months may begin to slow down based on three factors: lower raw material costs as commodity prices decline; easing of supply bottlenecks, with fewer cargo ships waiting at ports and resolution of the global semiconductor shortage; and signs of an improving labour market.
The latest US job figures show participants in the workforce have increased, especially among women as the reopening of schools has freed more mothers to return to work. However, we see rents and wages (reflecting inflation expectations and likely to become a permanent component of inflation) continue to rise. Consequently, the Fed has to accelerate QE tapering and possibly raise interest rates faster to reduce inflation expectations.
SLOW-GROWTH RISK
In our view, the risk to the US economy is slower growth rather than inflation. We are starting to see early signs inflation will ease in the second half of 2022 as the economy slows down, both from reduced fiscal and monetary stimulus and the increasing risk of a global economic slowdown, especially in China. This week the People's Bank of China cut the one-year lending rate, the de facto policy rate, for the first time in almost two years.
Our worry is that if the Fed acts too quickly amid a gradual drop in inflation, over-tightening may occur. This could lead to a recession in late 2022 or early 2023 -- keep in mind that 90% of past recessions were caused by the Fed raising rates too quickly. We think the bond market is starting to reflect this idea, as seen in the decline in long-term yields.
We see the unhappy combination of faster Fed tapering, Omicron and the slowdown in China as creating greater economic risks in the first quarter of 2022. While inflation will remain high early in the year due to low-base effects, economic indicators may soon start to slow down sharply, which will lead to stagflation fear. It is possible that we may see purchasing managers' index figures fall sharply worldwide in the first quarter.
Although we still believe the global economy will return to "normal" next year, the risks have risen greatly and the economy could be back in the doldrums at any time.
Piyasak Manason is senior vice-president and head of the wealth research department at SCB Securities, email piyasak.manason@scb.co.th