On the February 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 outlook for global growth, the potential moderation of inflation, and the Federal Reserve’s (the Fed’s) effort to address rising prices without stifling economic growth.
The February CIO Call participants believe the macro backdrop still remains generally supportive of risky assets. Growth is likely to rebound in the second quarter of 2022 after a likely hit in the first. Inflation is still expected to remain above the Fed’s target in 2022, but goods prices might start falling before the end of the year as inventories rise, easing inflation, to some extent.
While corporate earnings have been strong during the current earnings season, and expectations are solid, there are risks of a potential squeeze on company margins from reduced pricing power. Global central banks, including the Fed, have adopted a more hawkish stance amid their efforts to normalize policy. While the Fed is likely to be cautious in tightening policy despite its perceived hawkishness, its data dependence could keep markets sensitive to economic data and rate expectations. While growth is likely to improve after taking a hit from Omicron in the first quarter of 2022, elevated inflation and central banks’ balancing act amid normalizing policy is likely to keep markets choppy in the near term.
The global economy is expected to transition to a more normal growth pace over the course of 2022. While the Omicron virus is likely to have an impact on growth in Q1, economic growth is expected to rebound in Q2 2022, just as growth spiked after the worst of the Delta virus outbreak last year. Global economic activity was robust in Q4 2021, despite the swift spread of the Omicron variant later in the quarter. While Omicron likely played a role in disrupting activity, a lower mortality rate helped reduce the need to reinstate many of the more severe restrictions that had been imposed during prior waves. However, global gross domestic product (GDP) growth is still expected to slow to around 3% annualized in Q1 2022 after a strong 6% rebound in Q4 2021.
US GDP rose more than expected in Q4 2021, up 6.9% annualized (5.5% expected) after a 2.3% increase in Q3. Firms rebuilding inventories helped drive economic activity in Q4 (adding 4.9% to growth), as did consumption spending (adding 2.9% to growth). However, current expectations are that the strong contribution of inventories in Q4 may unwind to some extent in Q1 2022, reducing GDP growth. In addition, the Omicron variant is likely to weigh on growth in early Q1.
Eurozone GDP growth came in slightly lower than expected in Q4 2021, up 1.2% after 9.5% previously. German GDP had disappointed, declining -2.8% after rising 7% previously, while French GDP rose solidly, up 2.8% after 13%. Japanese GDP growth for Q4 is expected to rebound over 6% quarter-over-quarter annualized after a disappointing -3.6% contraction in Q3, 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. Incoming Q4 GDP releases from emerging markets (EM) show strong growth across EM Asia, consistent with some easing of supply bottlenecks and a pickup in regional demand as Delta drags fade. However, Q1 2022 growth is likely to take a hit as Omicron and elevated inflation threaten to dampen consumer and external demand.
Inflation Surges in 2021
Global inflation spiked over the course of 2021, averaging 4.7% in Q4 2021. There are some signs that while year-over-year inflation is likely to remain elevated at least in the near term, the sequential pace of increases has slowed recently. The global headline CPI rose 0.3% month-over-month in December, a significant decline from the 0.6% pace in October and November. Global energy inflation flat-lined in December after averaging a 3.7% monthly gain in the prior two months.
Call participants continue to expect inflation to moderate over the course of the year, although US inflation is still likely to remain above the Fed’s target. Shelter inflation, which plays out with a lag, remains elevated, while services prices still have room to rise after the soft patch in Q1 2022. However, goods prices might start falling before the end of the year as inventories rise, and the goods-versus-services composition of demand shifts more toward services. With governments pulling back on additional fiscal stimulus, slower aggregate demand could also soften inflation going forward. US inflation hit 7% year-overyear in December 2021, the highest rate since 1982, after rising by 6.8% in November. US core inflation increased to 5.5% from 4.9% previously. Eurozone headline inflation climbed to 5% year-over-year in December (from 4.9% previously), but core inflation remained unchanged at 2.6%. Japanese nationwide inflation, though rising, remains more contained, with nationwide headline inflation up 0.8% in December after increasing by 0.6% the prior month. Excluding fresh food and energy, it remains low, down -0.7%.
On the policy front, the Fed and other major central banks are trying to calibrate their monetary policy to address elevated inflation, while still supporting economic growth. At its late January 2022 meeting, the Fed signaled it will raise interest rates at its next meeting in March with the statement highlighting inflation above 2% and a strong labor market as the reasons for the rate lift-off. Current expectations are for the Fed to hike rates three to four times in 2022. The Fed also announced it will slow asset purchases and terminate them in March (as expected). Fed Chair Powell’s comments indicated the Fed is more aggressive than at similar junctures in the past. “We know that the economy is in a very different place than it was when we began raising rates in 2015...and these differences are likely to have important implications for the appropriate pace of policy adjustments,” Powell said.
While the European Central Bank remains concerned about the outlook for inflation, it is unlikely to hike policy rates in 2022, though it may begin signaling rate hikes for 2023 later in the year. The Bank of Japan left policy unchanged at its mid-January meeting, leaving rates at near zero and continuing its yield-curve control policy.
Other major developed market and EM central banks have generally turned more hawkish this year. The Bank of England is likely to hike rates further even as the UK labor market shrugs off expiring government job support and Omicron drags. Even in Australia, expectations for rate hikes have now been pulled forward into later this year. In emerging markets, policy rates continue moving higher with 14 of the 23 major EM central banks expected to hike this quarter. However, policy in China is going against this tide. Amid all these cross currents, Powell noted that the Fed aims to remain nimble-a point taken to mean the Fed is attuned to two-sided risks and not necessarily as hawkish as the market believes. Each meeting is expected to be “live” with policy decisions conditional on how the economy and its outlook shape up this year. Given two-way risks, the Fed is expected to proceed with some caution in its rate hikes and balance-sheet taper this year.