Dec 16, 2021

Economic and Market Risks to Watch for in 2022

While there are signs that the global economy and markets are awakening after a pandemic-induced slumber, this year has proven that a path to normalcy is going to be uneven and challenging. As 2021 draws to a close, there are a handful of risks that could affect markets in the new year.

Below are the top five risks that AIMCo believes the global economy faces in 2022. The risks are listed in descending order, ending on the greatest risk the global economy is up against.

5. Debt Burdens

Since 2019, governments, corporations and households have taken on record amounts of debt to battle the COVID-19 pandemic. In most instances, societies around the world are on the cusp of becoming more indebted than at any point in history.

Massive borrowing by governments during the pandemic lightened the blow of lockdowns, plunging consumer spending and millions of lost jobs. In the case of businesses, borrowing more money allowed companies to pay the employees they didn’t lay off and maintain their capital spending programs. For households, government borrowing and loan deferrals helped pay rent and buy food.

Over the past number of years, historically low interest rates have kept debt obligations manageable and affordable. But if rates rise faster and higher than markets are anticipating, the end of the pandemic could mark trouble for global financial markets.

The run up in borrowing to combat COVID-19 varied from country to country. Developed nations, with easier access to capital markets, have spent more to ensure stability, while emerging market governments have had to do so with fewer resources.

Yet as a full recovery gathers momentum, the of risk of the debt burden could change. Central banks may face tough trade-offs between managing inflation and maintaining supportive policies in the years ahead.

4. Chinese Real Estate

The Chinese economy also faces debt risk that could bleed into the global financial system. There remain fears that one of China’s largest property developers, Evergrande, could be on the brink of defaulting on its debts.

“Real estate is very important to the Chinese economy,” said Jean David Tremblay-Frenette, Director of Investment Strategy Research. By some estimates, real estate accounts for nearly 25% of gross domestic product (GDP) in China (including both upstream and downstream activities across the construction sector, etc.). That’s because home ownership among Chinese is highly sought after. So, for years, property developers like Evergrande have built residential properties to satiate demand. However, supply has outmatched demand for some time already.

Despite the risk, investors should not be worried. The risk of Evergrande experiencing a hard default is very low. First, Evergrande has been trading lower in Asia since June of this year, so much of the risk has already been baked in.

Second, in the past few years, the amount of corporate debt that's been gathered in China has been great. This has been concentrated in a few sectors like property. That's why the Chinese government will do whatever it takes to prevent a ‘Lehman Brothers moment.’

Still, if Evergrande misses any payments, the Chinese government has a few options and AIMCo expects that it will act to prevent a domestic solvency crisis and broader global financial contagion. For the remainder of 2021 and heading into 2022, the Chinese property sector will be impacted negatively and China’s GDP growth might suffer as well.

3. COVID Variants

Vaccines, improved testing and greater information about COVID-19 triggered optimism about how nations would navigate out of the pandemic. But this past summer, worries surfaced about new variants, specifically the Delta variant. This mutation of the original COVID-19 virus is more severe and about two times more contagious than previous variants.

Now, however, there is a faster-spreading variant named Omicron. This mutated version of the original COVID-19 virus was first detected in South Africa and is now spreading across Africa, Europe and North America. Even though early research suggests that Omicron is more infectious than past variants, the good news is that for now, health experts have found no evidence it causes more severe illness. Furthermore, research to date suggests that current vaccines remain effective against fighting infection and spread.

Why does this matter? The longer the pandemic lasts, the greater the likelihood of spread and mutation, the greater the risk of markets pricing weak growth.

2. Supply Chain Issues

Back in 2020, governments around the world shut down factories to prevent the furious spread of COVID-19. This shutdown caused a shortage of goods and induced demand for all types of products and services. Now in 2021, as the global economy re-emerges and demand continues to surge, serious bottlenecks and supply chain disruptions are a significant downside risk to domestic and global economic growth.

The consequences of the logistics crunch are extensive. A lack of cargo containers and containers sitting idle at ports is affecting the transportation of medical supplies and even food. Additionally, a shortage of supply chain workers such as truck drivers and warehouse workers is causing delays in the supply chain and other labour-related issues. Simultaneously, small businesses face lengthy lead times and are worried that without key inputs to their business and other essential business goods they’ll lose critical holiday season sales and may have to close their doors.

Although AIMCo expects global supply chain issues to be mostly resolved by the second half of 2022, the longer the supply chain disruption lasts, the greater the risk to economic growth and to markets. If the current logistics issues aren’t dealt with, the recovery from COVID-19 will be even more choppy. Prices for goods and services may continue to rise significantly causing chronic inflation.

1. Inflation

From gasoline to the cost of a new sofa, prices are on the rise. The main reason for the drastic rise in the price of goods and services has to do with reopening the economy after a lengthy shutdown. Government-mandated shutdowns inflicted turmoil and many sectors and businesses have since had to increase their prices to stay open. Rising prices are also linked to the increase in the amount of money circulating in the financial system . This is a result of federal stimulus packages like the Canada Recovery Benefit (CRB) which have helped cushion the economic shock of the COVID-19 pandemic.

Even though COVID has made filling your car and redecorating your living room more expensive, AIMCo believes the risk of prices rising consistently into the future is low, for now.

“We expected inflation to gradually rise throughout 2021 continuing into the early part of 2022. As a result, central bank rhetoric has begun preparing for moves to control inflation. But even with a measured exit from extremely accommodative conditions via asset purchase tapering, monetary policy is not anticipated to become materially restrictive in the near term,” said Tremblay-Frenette.

The Bank of Canada and other central banks around the world have begun to or signalled that they will taper their monetary policies, like quantitative easing. They’ve also expressed that they will continue to provide the appropriate degree of monetary policy stimulus to support a healthy economic recovery and achieve stable inflation for the long term. Still, if central banks around the world act too late and if supply chain issues aren’t resolved in the immediate term, the outcome may be higher prices for a longer period of time.

High inflation makes life more difficult for people whose incomes don’t keep pace with rising prices, such as low-income earners and pensioners. This is because high inflation decreases the value of their incomes and savings.

The post-pandemic recovery is expected to pick up momentum next year meaning many economic indicators like employment will continue to improve. With these improvements, global growth and economies around the world are on track to see better days. Still, the five economic risks outlined in this article could derail the economic momentum that’s been building and prove problematic in 2022.