And even if the new version turns out to be harmful, the experience of the world economy with Delta shows that it will only serve to delay and not radically change the trajectory of the world economy. Despite the deadly rampage of the Delta version in the middle of the year, other variables outside of Covid itself have also begun to have a significant impact on the global economic trajectory. There was the constant drumbeat of Fed monetary tightening, the dramatic implosion of China's real estate sector, and the sharp rise in inflation that swept the world as growth picked up again.
In the following pages, we will focus on these possibilities, allowing us to get a clearer picture of the possible paths that 2022 could take as the world emerges from its post-pandemic malaise. However, the emergence of the Omicron variant illustrates Covid's persistent threat despite these emerging signs of normalcy. In this sense, Omicron is a litmus test of whether Covid is really well on its way to being an endemic disease, or in other words, just another species of the flu.
This risk is further amplified if the world ends up in a scenario where China, still sticking to its zero-Covid strategy, imposes much stricter lockdowns than most parts of the world. A resurgence of Covid could exacerbate supply chain disruptions if China remains more vulnerable to lockdown than the rest of the country. It is a sign of the new economic zeitgeist that forecasts of Omicron's worst effects are as likely to worry about higher prices as cooler growth.
Indeed, the dramatic return in 2021 of inflationary increases not seen for a decade is perhaps the most prolific symbol of the new economic vistas of the post-Covid world.
Price gains have been disproportionately concentrated in energy and vehicles in the US and EU
Inflation
Price gains have been disproportionately concentrated in energy and autos in the US and EU. This suggests that supply factors remain the main drivers of the current period of inflation. Indeed, a closer look at the statistics supporting the Great Recession offers hints that much of the current labor squeeze may just be a temporary adjustment to pandemic-era distortions.
This suggests that many of the layoffs we have seen may be driven by fear among older people of contracting Covid-19. The majority of redundancies took place in low-wage sectors, such as leisure and hospitality, rather than in the white-collar strongholds of the financial and information sectors (Figure 5). Fundamentally, then, there is a possibility that much of the current strength of labor market bargaining power is a function of Covid-era disruptions, perhaps best reflected in the leisure and hospitality sectors.
The highly customer-oriented nature of the sector may also discourage new hires due to coronavirus-related fears. So much of the labor market turmoil may be primarily driven by workers taking advantage of the large number of vacancies to move into better-paying jobs.
Wage gains are largely being driven by low-wage jobs, with high- income wage growth actually declining
Median monthly wage growth (%)
Wage Quartile
Job quits appear to be higher for industries with lower wages, particularly the leisure and hospitality sector
Quits Rate (%)Average Hourly Wage (USD/hr)
16Part II: Inflation
Shipping indices suggest that supply chain disruptions may have already peaked
Baltic Dry Index
Harpex Shipping Index
Fossil fuels
Minerals
Agriculture
Energy prices have historically been much more volatile than other commodity prices, and may remain more elevated for longer periods
Fossil fuel financing (in terms of loans and bonds) has declined relative to green financing…
Fossil Fuel Financing Green FinancingUSD Tn
Nuclear Coal
Gas (Combined Cycle)
Levelized Cost of Energy* (USD/MWh)Part II: Inflation
Apart from its direct economic effects, inflation is also important, as its intensity will have a direct influence on the course of US policy. The current inflationary environment, with rising commodity prices, favors emerging market commodity exporters over the industrial producers and consumers who rely on these commodities. The US's unique economic and financial role in the world economy effectively gives it the tools to change this environment if it wanted to.
So the outsized economic influence of US policies must be kept in mind as we try to chart the path forward in 2022. On a monetary level, the US at least appears to have taken steps to reverse the current economic equilibrium. In line with markets' steadily rising expectations for higher interest rates, the Fed announced its plans to accelerate the taper and raise rates two to three times in 2022.
22Part III: US policy
US policy
24Part III: US policy
Much of the remarkable recovery of the US economy over the past two years can be attributed to its massive fiscal relief package, which has been somewhere between 25-30% of GDP. But it is likely that such a large transfusion of fiscal money will not happen again in 2022. The Biden administration's $1.2 trillion infrastructure bill, to be spread over a decade, is less than 1% of GDP per year, but a pale shadow of the US's massive covid bill.
The looming 2022 midterm elections also mean that Democrats' razor-thin majority in the Senate is in jeopardy, especially considering that the ruling party typically does worse during midterm elections. The possibility of a new split government further reduces the chance of drastic new budget relief. The Fed's apparently aggressive policies, as well as the tapering of Covid-era fiscal stimulus, mean that US growth may be more likely to trend downward in 2022.
Over the past twenty years, the global consumption engine has largely been the US. The dollar's reserve currency status essentially allows the U.S. to tap other countries' money. With political willingness to spend on budgets declining, US growth is likely to slow in the coming years.
Indeed, we see that the size of the rest of the world's trade surpluses tends to move in line with the US trade deficit (Figure 15). The warmer the US economy, the more goods it imports from the rest of the world. The massive fiscal stimulus of 2020-2021 caused the US trade deficit to widen, which in turn drove record surpluses in other parts of the world.
Viewed through this lens, global growth is deeply intertwined with the strength of the US economy.
USD Index (lhs) S&P Commodity Index (rhs)
Commodity prices tend to move inversely to the strength of the US dollar
Margin Debt (lhs)
A combination of low rates and high inflation helped drive real interest rates into negative territory, but for how long?
US Treasury 10Y
Markets are still expecting only two rate hikes in 2022, despite the Fed dot plot indicating three likely hikes
Fed Funds Rate Futures, maturation on
Yield spreads suggest that while markets see relatively fewer risks in the short term, they are growing increasingly
US Treasury Yield Spreads
The export strength of most countries is largely driven by the size of the US trade deficit
US China EU Rest of the WorldTrade Balance, 12M moving average (USD Mn)
The export strength of most countries is largely driven by the size of the US trade deficit. In the case of the USA, this role of net producer is increasingly fulfilled by China. On the opposite side of the US trade deficit lies the Chinese trade surplus.
This sums up so much of the global economy's distribution of labor: the US is the world's consumer of last resort, China provides the industrial prowess to supply US demand, and the New World provides the raw materials needed to power Chinese industry. The financial implosion of Evergrande and China's real estate sector in 2021, and the government's subsequent crackdown, seems to epitomize much that has begun a path of slower growth, but China also began to experience a series of severe economic convulsions in 2021. But at the heart of these recent events are long-term, structural problems that go back to the very origins of China's current economic model.
Characteristic of most East Asian developing states, China's economic model has historically relied on a variety of means—particularly financial repression—to transfer money from households to businesses.
China
34Part IV: China
China relied primarily on its growing trade surplus to boost growth in the years leading up to 2008. After US demand plummeted however, China had
Current Account (lhs) Debt (rhs)
36China has a disproportionately large share of investment to GDP, and a
Taiwan Korea
Now that each variable has been explored in detail, all that remains is to consider how their interactions with each other are likely to shape the coming year. Based on how some key variables such as Covid and inflation are likely to play out in 2022, we draw four primary scenarios built around the likely trajectories of the world's two main economic engines: the US and China. The combined cooling (or warming) of the two economies will be a key determinant in the movement of commodity prices and, by extension, the economic health of the developing world.
Each scenario is then compared to a historical analogy, with each corresponding to a specific stage in the economic cycle of the past two decades, one perhaps best characterized by the consumer-producer relationship that previously existed between the US and China is outlined.
Mapping out 2022
Scenario #1: Global cooling 40%
Scenario #2: An emerging market boom? 40%
Scenario #3: Industrial relocation? 10%
Scenario #4: Firing on all cylinders 10%
Repo Rate
Projections of the 10-year yield and the USD/IDR exchange rate refer to fundamentals; actual market values may vary based on sentiment and technical factors. This report is for informational purposes only and is not intended as an offer or solicitation to buy or sell any security. We believe that the information in this report is taken from sources we believe to be reliable.
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