Global equity markets are ending the year with the steepest declines in years, while for the bond market, 2022 will be the worst year in the 21st century.
Investors are cautiously optimistic about the year ahead, hoping for an end to the cycle of interest rate hikes, a Chinese economic recovery and a resolution of the conflict in Europe. However, their plans may be hampered by five key risks, according to Bloomberg.
INFLATION
“The bond market expects inflation to return to an acceptable range in the next 12 months,” said Matthew McLennan of First Eagle Investment Management.
But that outlook could be misleading, he cautioned, because rising wages and supply-side pressures, including energy prices, could lead to long-term increases in consumer prices.
If inflation proves more resilient than the market suggests, the Federal Reserve and the European Central Bank are unlikely to stop raising rates in the first half of the year, let alone lower them. In turn, this will cause further declines in stocks and bonds, a stronger dollar and difficulties for emerging markets. Rising borrowing costs could also trigger a recession.
“The Fed has failed to anticipate inflation and in its quest to beat inflation may miss the looming problem in the financial market,” McLennan warned. – It is quite possible that the Fed is underestimating the risks of financial disaster.”
CHINA’S PROBLEMS.
China’s stock index has jumped 35% from its October low on expectations of the removal of recent restrictions and lockdowns in the world’s second-largest economy.
But there is a danger of an uncontrolled rise in coronavirus diseases that China’s health care system cannot cope with, and then the country faces a collapse in business activity.
“The disease trajectory in China will rise and peak only a month or two after the Lunar New Year,” said JPMorgan Chase market strategist Marcella Chow.
China’s stock market recovery remains fragile and the prospect of declining economic activity could collapse demand for commodities, especially industrial metals and iron ore.
SITUATION IN UKRAINE
“If the situation worsens, NATO gets more involved in the fighting, and sanctions increase, that would be quite a negative,” said Nikko Asset Management senior strategist John Weil.
Secondary sanctions on Russia’s trading partners, mainly India and China, will only intensify the effect of existing bans at a very dangerous time for the global economy, he added.
“The world faces a supply crisis in terms of food, energy and other commodities, including fertilizers, some metals and chemical products,” the expert wrote.
COLLAPSE OF EMERGING MARKETS
Many investors expect a weaker dollar and lower fuel prices in 2023 to support emerging markets.
However, any difficulties in fighting inflation will keep the dollar down, and escalating hostilities in Ukraine is just one of many risks that could lead to another surge in fuel prices.
“It could very well turn out to be another tough year for emerging markets,” says Shane Oliver, head of investment strategy and economics at AMP Services Ltd. Shane Oliver. – “The still high likelihood of a rising dollar is a negative factor for them because many have dollar obligations.
A stronger dollar makes it difficult for countries to service U.S.-currency-denominated government debt.
THE RETURN OF THE CORONAVIRUS
The emergence of a more contagious or deadly strain of coronavirus, or even the spread of existing variants, could cause supply chain problems again, which in turn would cause inflation to rise and economic activity to slow.
“We think the impact on macroeconomics and growth will be felt mainly by large economies and countries that are more dependent on foreign trade,” JPMorgan’s Chow said.
However, her baseline scenario assumes that the coronavirus will continue to retreat, and the main negative factor for markets will be a possible recession in the U.S. and Europe.