Big macro vs little macro

Economist and best-selling author JK Galbraith once quipped that there are two kinds of forecasters: those who don’t know and those who don’t know they don’t know. Turns out, it may be worse. If economics were a hard science, its first law would be: for every economist, there exists an equal and opposite economist. And the second one: they’re both wrong. To be clear, even though all macro models may be wrong, some are useful. Our Counterpoint 2022 doesn’t focus so much on the ‘little macro’ changes, like what will happen to inflation and interest rates next month – though getting that right is tough enough. Rather, it looks at the ‘big macro’ changes that could impact the global economy and capital markets this year and beyond. While our outlook lays out our base case for 2022, we’re not married to pre-set conclusions. We care more about how we arrive at those conclusions: the mechanics – our understanding of the cause-effect logic behind them. As things inevitably change, the same mechanics could point to different conclusions over time.

We’ve identified five calls we believe will dominate the global economy and financial markets this year:

Call #1: the cycle | Moving past the peak: There’s really no consensus on this one, partly as Omicron and, potentially, other virus variants raise uncertainty. Some investors think we’ll soon slow sharply as shortages hinder economic activity. Others think we’re overheating, and so central banks and governments will soon take away the punch bowl, removing a key supporting factor for financial markets. Our view is that we’re now moving past the peak in growth as the boost from reopening is behind us and policy stimulus, while still supportive, becomes less intense. Over time, we’ll also move past Covid-19 (or learn to cope with it) and so the level of activity should continue to rise as spare capacity is reabsorbed. We think we will move past peak inflation in 2022, partly because supply is expanding and partly as pent-up demand eventually gets fully spent. With cyclical acceleration no longer the dominant driver, financial markets may be less well supported in the near term. But with the economy continuing to grow and policy remaining easy on the whole, the riskier asset classes such as equities and credit should still outperform safer bonds.

Call #2: rates & FX | Off the lows: Some investors worry that we’re set for an imminent and fast rate hiking cycle, as central banks tighten soon and relatively decisively. We take the opposite view. To cushion the fallout from Covid-19, central banks deployed unprecedented policy support to cap borrowing costs so governments could spend aggressively. Core sovereign bond yields, which had already been on a secular downtrend, fell further in response to lower policy rates and scaled-up asset purchases. As the world economy recovers more visibly and job creation comes back, central banks are now tapering their asset purchases. The next step is rate hikes. We believe this will happen in a more gradual fashion than market participants at times worry about. We may be about to see higher, but by no means high, bond yields, as they’re starting to rise from record-low levels. As this happens unevenly across countries and regions, with the Fed and the Bank of England leading the way and the European Central Bank lagging behind, we see Treasury and Gilt yields rising more than Bund yields, and the dollar and sterling appreciating versus the euro.

Call #3: China | Eastern promises: The consensus thinks that China is hard to read. An economy this size presents opportunities, but it also looks riskier than other regions. Concerns range from the impact on climate change to vulnerable supply chains and regulatory tightening across key industries. We’re more positive on China. We frame any investment in risk-adjusted terms. Of course, there’s some extra risk to consider when looking at emerging markets relative to comparable opportunities in developed markets. They include environmental, social and governance (ESG) factors, but also geopolitical issues, especially when it comes to the credibility of promises to address some of these factors. But an economy and capital market as large as China is critical for understanding the global cycle. We think China’s transition promises to create an institutional and regulatory infrastructure to prioritise long-term development, also in terms of achieving its ‘net zero’ ambitions, rather than short-term growth. This may present investment angles and market perspectives worth exploring.

Call #4: infrastructure | No place like home: Investors tend to agree that the pandemic has highlighted that global infrastructure requires significant upgrades. However, while this should stimulate economic growth, the consensus also seems to believe that marrying sustainability objectives with construction and production isn’t easy. Our view is that our planet is our home – and it’s the only one we have. Spending on infrastructure looks set to rise. Some of the projects are physical – roads, bridges, railroads and other public projects. Others are in green and digital areas. Policymakers are aware of climate change and the need to support human capital, which suggests to us that the effort to make infrastructure more sustainable is structural. This shift from emergency fiscal support to outright public investment, plus regulatory and sustainability considerations, is likely to be important for other sectors too. The segments of the real estate market that can flexibly adapt to these structural changes may benefit, along with logistics and warehousing.

Call #5: technology & productivity | Innovation nation: It’s easy to be bullish on the tech sector, but what it means in practice and how to pick winners is less clear. So, according to the consensus view, whether innovation can really help address the key global challenges of this age remains to be seen. While we agree that choosing the right sectors and companies is key, and for that we think a bottom-up approach like ours is crucial, we also think three key top-down trends are gaining momentum, turbocharged by the pandemic. First, rising R&D spending, especially in disruptive technologies. Second, expanding capital investment, in particular in intellectual property, greener solutions and infrastructure. Third, faster productivity spreading across countries and sectors. We expect public and private firms, as well as investment themes at the intersection of all these innovation waves, to benefit. We regard this as a structural trend spanning many years.

Meanwhile, the calendar is getting busier…

Starting all over again: The key for markets is whether nonfarm payrolls (Friday) picked up momentum once again. At the December Fed press conference (minutes on Wednesday), Chair Powell said that the decline in the unemployment rate and the rise in labour force participation were key factors behind the central bank’s more hawkish pivot. The ISM surveys (Tuesday and Thursday) should revealed solid but no longer accelerating growth in the US. Whether China’s purchasing managers’ index for the manufacturing sector (Tuesday) stabilises could be relevant too. While it’s likely to take longer in the US and the UK, inflation in Germany (Thursday) and the euro area (Friday) should begin to slow from a high rate, courtesy of a drop in gasoline and heating oil prices plus base effects likely weakening the month-on-month price change relative to the typical seasonal pattern. Given this backdrop, the European Central Bank, unlike the Fed and the Bank of England, should continue with its net asset purchases – though at a reduced pace – and refrain from hiking this year.

Daniele Antonucci | Chief Economist & Macro Strategist