Outlook 2022: Slowflation to Expansion
By all accounts, 2021 was a good year, economically speaking. Production and distribution challenges of the mass vaccination drive are largely resolved. The world’s largest economies are firing on nearly all cylinders. Yet the latest COVID-19 variant suggests that the global pandemic is not quite in the rearview mirror, so the associated economic disruption and the resultant inflationary pressures may persist well into 2022.
As of early December 2021, more than half of the world’s population of roughly 4.3 billion people had received at least one dose of the various COVID-19 vaccines. Annualized COVID-19 vaccine production ramped up from fewer than 100 million doses in January 2021 to more than 12 billion doses by December 2021. This extraordinary achievement resulted from close scientific, technical, and financial collaboration across companies; the effort defied national borders and spanned the globe. It suggests that requiems for globalization may be premature.
The global economy began to recover some of its operating momentum. Economic recovery was decidedly V-shaped, in sharp contrast to our experience after the Global Financial Crisis (GFC). By the middle of the year, both sides of the Atlantic were growing at double-digit rates in year-over-year terms. The Atlanta Federal Reserve (Fed) nowcast model currently estimates that the U.S. economy is expanding at a 6.8% quarter-over-quarter annualized rate.
The emergence of the Omicron variant in late November reminded us that the pandemic is not quite in the last innings, to borrow a baseball analogy. More supply-chain disruptions may lie ahead, and the associated inflationary pressures will likely persist this year. So what do all these developments purport for the global economy in 2022 then?
The world economy most likely entered 2022 with strong growth momentum, which will likely dissipate as the major economies near their pre-COVID trajectory. Once the pandemic is behind us, unpredictable supply disruptions should recede, and the current bout of inflation will likely subside. “Slowflation” may make for a tougher backdrop for equities, in contrast to the strong returns equities provided as the “mother of all recoveries” unfolded.
Our expectations for output growth and inflation in 2022 rest on two key assumptions. First, we expect global vaccination efforts to reach near-universal levels by the second half of 2022 so that end-to-end supply chains can resume working as intended. Second, we assume structural growth decelerates to pre-pandemic trends as economies approach the pre-2020 output trajectory. Our outlook for supply-chain normalization and healthy economic activity is predicated on the expectation that COVID-19 follows past pandemic influenza experiences, becoming less virulent over time.
The chart below illustrates our estimates for the implied output trajectory in 2022. The top baseline reflects the conceptual output path for major developed market economies, assuming a 2% annual growth rate, consistent with the pre-pandemic experience.
The U.S. economy is much closer to its pre-pandemic output trajectory than are major European economies. Based on current trends, we expect the United States to reach its pre-crisis output by summer 2022 before settling into 2% annualized growth. In this scenario, full economic recovery implies significant sequential deceleration in annualized quarterly growth in 2022.
Most European economies remain somewhat below their pre-pandemic output trajectory, which leaves significant scope for strong growth throughout much of 2022. Thus, we believe European economies should generate stronger sequential growth than the United States, as we expect these economies, except Spain, to fully recover to pre-pandemic output by the end of 2022.
As China’s economy fully recovered by the end of 2020, growth in China decelerated materially in 2021, to the point where macroeconomic policy is already becoming more supportive of near-term growth pickup on the margin. On December 6, 2021, the People’s Bank of China announced a 50-basis-point reserve requirement ratio (RRR) cut, enabling banks to lend more. We expect China’s economy to accelerate gradually in 2022 as domestic policy is calibrated to reach annual output growth of 6% or more.
With output still well below trend on both sides of the Atlantic, rising inflation, especially in the United States, is largely a function of persistent and sudden supply disruptions as the pandemic continues to wreak havoc. COVID-19 exposed the weakness of pairing global supply chains with purely national responses to medical challenges: China pursued zero tolerance of infections, while the United States and many other countries embraced economic activity while minimizing severe illness outcomes.
The supply of goods has become a victim of rolling supply disruptions. Such divergence in national response translates into impossible-to-anticipate, sporadic, highly disruptive closures of plants and ports located in China. These rolling closures reverberated throughout the world economy for months after the initial disruption, as China’s ports process nearly 50% of global container volumes. This is why goods prices are rising at a 12% rate, a sharp and temporary reversal of multi-decade price deflation. The chart below details annual changes in U.S. goods price inflation relative to shipping rates.
In addition, U.S. consumers feel another, more concentrated impact of COVID-19 on car prices. Many car producers underestimated the strength of demand resumption and canceled semiconductor orders, so today the current annualized supply is running 3 million to 4 million vehicles short of the pre-pandemic rate. A lack of new cars, in turn, elevates the prices of used vehicles, which is evident in the U.S. monthly consumer price inflation data. The chart below shows new and used vehicles’ abnormal contribution to annual inflation as the recovery unfolded.
As the supply of semiconductors normalizes and new vehicles roll off the assembly lines in sufficient quantities, we believe price pressures are likely to subside.
Purchasing patterns suggest that consumers do not expect pricing pressures and scarcity to persist: there are no signs of hoarding. In fact, the supply-demand adjustment is occurring as expected: consumers are postponing purchases in response to higher prices. Overall demand declined more than 10% since the reopening peak, with much of the deceleration concentrated in motor vehicles. Consumers are postponing purchases, and surveys indicate that affordability is not a deterrent. Instead, people believe that prices are too high at the moment and expect them to decline.
We believe 2022 is shaping up to be one of slowing toward healthy rates of economic growth and inflation, thereby paving the way to a sustainable, multiyear expansion.
Olga Bitel, partner, is a global strategist on William Blair’s Global Equity team.
Emerging Markets 2022 Outlook Series
Part 1: Slowflation to Expansion
Part 2: Headwinds Abate for Emerging Markets Equities
Part 3: A Brighter Outlook for Emerging Markets Debt
Part 4: China: Opportunities at an Inflection Point