On the January PGIM CIOs Call hosted by PGIM Quantitative Solutions, chief investment officers and senior investment professionals from PGIM's international businesses, PGIM Fixed Income, and PGIM Quantitative Solutions discussed the global economic recovery, the outlook for inflation and the impact of monetary policy tightening on the financial markets.
The January PGIM CIO call participants discussed the prospects for the global economy in 2022, focusing on Omicron and the transition away from the fiscal and monetary policy measures introduced to support the global economy. While the Omicron variant is sweeping across the world and has turned out to be highly contagious, the good news is that most cases have been mild, and hospitalizations remain lower than during prior waves. Based on the experiences of countries that were impacted first, we expect Omicron cases will fade quickly, which could mean that the economic impact might be over by Q1 2022. Growth for the full year is still expected to remain above potential but to be lower than it was in 2021.
The CIO call participants have an optimistic view for the year. They expect that economic growth will continue to exceed potential, albeit not as much as over the past year. While the less deadly Omicron variant has been spreading swiftly, high vaccination rates and natural immunity have kept death rates from rising significantly. With governments, businesses, and individuals becoming more adept at handling the virus the economic impact of future variants is expected to be less severe than past variants.
Global Growth Expected to Remain Solid
Global GDP growth remains on track to post a solid rebound in the fourth quarter of 2021 despite the impact of Omicron. The JP Morgan global GDP Nowcast is tracking around 6% annualized for Q4 after 3% in Q3 and 4.4% in the first half of 2021. US GDP is expected to rebound to around 6% quarter-over-quarter annualized in Q4 2021 after slowing to 2.3% in Q3.
While the Omicron variant likely disrupted some activity in late Q4, October and November were little affected, with strong global demand supporting robust growth in retail sales, employment, and industrial production. US GDP is expected to slow to below 4% in 2022 after growing at around 5.5% in 2021. Eurozone GDP is expected to slow in Q4 to a still favorable 2.8% annualized pace after the easing of COVID-19 restrictions boosted GDP by 9.1% in Q3. The spread of Omicron may hold back some activity in the second half of Q4. While supply constraints remain a concern, industrial production data so far in Q4 (through October) has been solid.
Looking ahead, Eurozone growth is expected to remain sound at over 4% in 2022. Following a disappointing -3.6% contraction in Q3, Japanese GDP growth is expected to rebound to over 6% annualized in Q4, supported by strong industrial production and robust consumer spending. Strong global demand and the nearly $500-billion fiscal stimulus package announced in mid-November is expected to contribute to solid economic growth into 2022. The Japanese economy lagged other developed markets in 2021 with intermittent lockdowns and supply chain disruptions that hit the auto industry especially hard. GDP growth is expected to strengthen to around 3% after a 2% increase in 2021.
Inflation Likely to Moderate as 2022 Progresses
On the inflation front, the general expectation is for inflation to remain elevated in the near term but to ease gradually over the course of the year as supply-chain bottlenecks abate and disposable incomes dwindle. Still, persistently high inflation remains a risk given that some inflation components might continue to remain high due to the fact that - some components change very slowly. While markets have been quick to pencil in the removal of accommodative measures and rate hikes by central banks, there are differences across countries. Slower-than-expected growth and easing inflation could result in some of these tightening measures not materializing. Still, the risk of persistently high inflation keeps the specter of more aggressive central bank action in the background.
Global inflation remained elevated in Q4 2021, with estimates of headline inflation rising to around 4.9% in Q4 from 3.1% in Q2. Persistently high inflation last year increased concerns among policy makers and markets amid continued supply bottlenecks and elevated commodity prices. However, call participants generally expect inflation to moderate by the second half of the new year, although it remains to be seen to what extent the moderation happens. The focus is on supply-chain bottlenecks, which have shown some signs of easing after the year-end crunch.
On the demand side, elevated wage growth is not keeping pace with higher inflation, thus reducing disposable income. While some inflation components might still continue to remain elevated, it is more likely that inflation has peaked. US inflation is expected to remain stubbornly elevated in the first half of 2022, averaging around 4% to 5% due to 2021's supply constraints, rising energy prices and higher housing costs. As supply conditions ease and base effects take over, inflation is expected to moderate later in 2022, although both headline and core inflation are expected to remain above the Federal Reserve's (Fed) 2% target by year end.
There is still significant uncertainty around how sticky recent price increases have been. European inflation is expected to follow a similar pattern to that of the US in 2022, though current expectations are for base effects to send Eurozone inflation back below 2% by the end of 2022. Meanwhile, Japanese inflation is also expected to rise modestly through mid-2022, though it will likely remain low and stable throughout the year, especially when compared to inflation rates in other developed economies.
Policy No Longer a Tailwind
Fiscal policy measures implemented to mitigate the impact of the pandemic on the global economy have been rolled back almost everywhere. Were there to be a third round of fiscal stimulus in the US, it likely would be much smaller in size. Monetary policy is also being scaled back, but we are seeing differences across countries. As telegraphed by Fed Chairman Powell, the Fed doubled the speed of its quantitative easing taper in December. In addition, the Fed removed language that it would let inflation remain moderately above the 2% target for some time and that it would maintain its accommodative stance.
While the Fed is now expecting the appropriate policy path to include three interest rate hikes in 2022 (the markets have priced them in), PGIM's Fixed Income team believes three hikes are not certain because it expects growth to moderate and inflationary pressures to ease over the year. The European Central Bank (ECB) announced in December that it will steadily pull back on asset purchases. While the ECB remains concerned about the outlook for inflation, it is unlikely to hike policy rates in 2022. The Bank of Japan left policy unchanged and is expected to continue its yield curve control throughout 2022, keeping both short-term and long-term rates near zero.
Overall, the macro backdrop remains supportive of risky assets with growth expected to remain solid despite the impact of Omicron. While the general expectation is for economic activity to remain solid in 2022, policy support-strong in 2020-21-has reversed. Global central banks continue to remove monetary accommodation by reducing asset purchases and by hiking rates from very low levels. Nevertheless, this should remain a generally good environment for risk assets, one in which Fed rate hikes will likely lead to a slowdown in the rally for stocks, but not a reversal. While the general consensus among the call participants was that the macro backdrop remains supportive for risky assets, the lingering risk from the spread of the Omicron variant, elevated inflation and central banks starting to remove accommodation are likely to increase market volatility. Caution is warranted.