Investment and economic wild cards Central bank tightening and China's closed borders merit extra-close attention. By Kampon Adireksombat

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The economic and markets outlook is likely to remain uneven and uncertain — that's hardly a unique prediction in the world of economists and market strategists, including myself, in recent years.

However, with steady progress on vaccination and relatively mild effects from the Omicron variant, markets seem to agree that the impacts of Covid-19 are still with us but should be waning.

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Despite a growth slowdown, the solid recovery in the US labour markets — US unemployment of just 3.9% in December was close to the pre-pandemic level of 3.5% — combined with inflation that’s getting worse before getting better should convince the US Federal Reserve to tighten its ultra-loose monetary policies.

In short, growth normalisation and gradual policy tightening seem to be the most common themes of the 2022 economic and investment outlook. But there are two wild card factors that could surprise us, in my view.

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POLICY PERIL

First is too fast and too furious monetary policy tightening. So far, markets have partially priced in gradual Fed policy tightening, reflected by rising Fed funds futures and bond yields. It’s widely expected that the tapering programme (a slowdown in asset purchases) will finish in March, after which the Fed is likely to start raising its policy rate: three times this year and twice each in 2023 and 2024, based on the current consensus.

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But, the minutes of the December meeting of the Federal Open Market Committee caught markets by surprise with signs of faster-than-expected tightening. Most market participants now expect the Fed to start raising its policy rate in March (instead of June); some expect four rate hikes this year (versus three previously).

The biggest surprise is related to the balance sheet runoff, so called quantitative tightening (QT), which markets did not expect the Fed to mention at least until the second half of 2022. Now, the key focus is on how fast the US central bank will trim its balance sheet, given stubbornly high wage, energy and durable goods inflation in the first half of 2022. That balance sheet has more than doubled over the pandemic period, from US$4.2 trillion to $8.8 trillion.

Another monetary policy surprise could come from the European Central Bank (ECB). Its professed belief in slower policy tightening compared with its US counterpart could be challenged by more persistent than expected “green inflation” in Europe.

Given the strong commitment from the European Union on climate change strategy, energy prices on the continent, especially gas prices, could be higher for a longer period. As a result, the ECB might have to withdraw its stimulus packages faster than planned.

But if monetary policy tightening is too fast, the markets might be furious over rising bond yields, volatile equity markets, especially long-duration stocks. Emerging markets might have to deal with rising cost of funds and feel additional pressure from weakening local currencies.

ZERO-COVID CHINA

The second wild card would be too slow a relaxation by China of its tough cross-border travel restrictions. Given Beijing’s zealous pursuit of a zero-Covid policy, most economists and strategists did not expect China to relax its strict travel restrictions and quarantine measures in first half of 2022. But, some expect a relaxation in the second half, reflected in a back-loaded recovery in tourist arrivals and current account forecasts, especially countries that heavily rely on Chinese tourists, including Thailand.

So far, the Chinese government’s strict lockdown and closed-border measures remain intact, suggesting that Beijing will likely keep its zero-Covid policy at least until the end of the Winter Olympics in February, if not beyond. The government has also implemented selective easing measures to support a domestic demand recovery.

However, given that most Chinese have been fully vaccinated by Chinese inactivated virus vaccines, which are believed to be less effective against Omicron, the recent resurgence in Covid cases could convince the government to delay any return to cross-border travel until most residents have received Chinese-made mRNA vaccines.

However, the arrival of domestically made mRNA vaccines and new jabs for more than one billion people will likely take time. And, if the Chinese government decides to maintain its strict lockdown and closed borders until the end of 2022, countries that expect Chinese tourists to come back and support their recovery in 2022 may have to deal with sluggish tourism and volatile local currencies instead.

Kampon Adireksombat, PhD, is first senior vice-president of SCB Chief Investment Office (SCB CIO)

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