2022 Global Economic and Foreign Exchange Outlook - Welcome to Shanghai Commercial Bank Limited's website
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2022 Global Economic and
Foreign Exchange Outlook
Welcome to Shanghai Commercial Bank Limited’s website
Ryan Lam, CFA Head of Research ryan.lam@shacombank.com.hk +852 2841 5283 2
Contents
2 Theme#1 Switching to Lower Gear
5 Theme#2 The Revenge of Supply
7 Theme#3 Squeeze Me Gently
12 Them
Th eme#
e#4
Theme#4 4 Don’t
Don’
Do n t Fight
Figh
Fi g t th
gh thee Fe
FeddTheme#1 Switching to Lower Gear
We always know human determination and creativity will prevail in this pandemic. But when? Sooner than most expected.
Once roared out of the trough in the summer of 2020, the global economy has regained its once-lost dynamism. The
pandemic looks largely under control; employment has risen by millions; and GDP recovered far faster from the pandemic
than it did from the global financial crisis.
Exhibit 1: New COVID Cases Worldwide per day (‘000)
1,600
1,400
1,200
1,000
800
600
400
200
0
2020-01 2020-04 2020-07 2020-10 2021-01 2021-04 2021-07 2021-10
Source: Johns Hopkins University, Shanghai Commercial Bank
Exhibit 2: Global PMI
60
55
50
45
40
35
30
25
20
1
1
1
1
1
1
1
1
1
1
1
1
-0
-0
-0
-0
-0
-0
-0
-0
-0
-0
-0
-0
10
11
12
13
14
15
16
17
18
19
20
21
20
20
20
20
20
20
20
20
20
20
20
20
Manufacturing Service
Source: CEIC, Shanghai Commercial Bank
2By all accounts, it was supposed to be a festival of optimism. So why doesn’t it feel that way? In legendary hockey player
Wayne Gretzky’s telling, they are eyeing “where the puck is going to be, not where it has been.” The near future is most
vivid in the eyes of common, and unsettlingly, the three pillars of goldilocks – rapid recovery, subdued inflation and patient
central banks – are no longer in place.
Tightening Purse Strings
Evidently, we are facing an overheating economy. In a two-speed economy with debt-ridden public sector and fully-employed
private sector, but commonly shackled by scarce resources, policymaker should lean towards supply-side reform and a
reduced role for the state. This is precisely the policy prescription that is going to be delivered. Per the IMF, at the flick of a
switch, global fiscal deficit is projected to be nosedived from 7.9% of GDP in 2021 to 5.2% in 2022.
Exhibit 3: Fiscal Balance (% of GDP)
2018 2019 2020 2021E 2022E 2023E
0
–2
-2.5 -3.0 -3.0
–4 -3.6 -3.6
-4.2
-4.8 -5.2
–6
–8
-7.9
-8.8
–10
-10.2
-10.8
–12
Advanced economies World
Source: IMF, Shanghai Commercial Bank
The archaic model relying on fiscal largesse is now a passé. Even so, there are reasons for hope.
American consumer is still sitting on a mountain of cash, amounting to a whopping US$2 trillion, that has yet to be spent.
When the supply crunch recedes, they are in a good spot to fill the void left by the government.
Another thing merits attention is the spectacular medical advancement. The new antiviral drugs from Pfizer and Merck – if
approved and widely distributed – is a twofer. This allows popularity-seeking politician to switch strategy from zero tolerance
to living-with-COVID, thus resuming intercontinental travel ahead of the tourism high season; workers might also bid farewell
to the stop-start production cycle, which was a potent feature of the delta wave.
A note of caution is warranted, though. Peaking-off is often viewed as a dirty word, and so investors will inevitably veer
between the optimism about the signs of re-opening and skepticism about the scale of what is needed. The bottom line is,
modest growth means the society makes further progress from the prior year, which itself was a strong outcome.
3Holding More Promise
US: Watered-down stimulus check will act as a drag to growth in 2022. This should be somewhat backfilled by an unleashing
of excess savings of private households and the infrastructure bill. Fuelled by diminishing COVID effects on labor supply, pent-
up demand is the other tailwind. Taken together, we expect U.S. economy to grow by around 4.5% in 2022.
Europe: For better or for worse, the continent has bound itself with a cutback in fiscal stimulus. A long list of risk factors
that are brewing, including a renewed surge in natural gas prices, COVID spike, and geopolitical tension with Russia, seem
concentrated on the European front. All roads lead to a bumpy ride ahead.
UK: Soaring fuel prices and an upcoming hike in gas and electricity cap in April 2022 will weigh on households’ disposable
incomes. Despite that, a record number of job vacancies, on top of a pick-up in hiring intentions, suggest that the labour
market, a main impetus for its growth, remains intact.
Japan: Once deemed improbable, more than 70% of Japanese population is at present fully vaccinated. Thanks to the
vaccination shield, the on-and-off lockdown will not return in the way it did in 2021. Services consumption will probably
show a new lease of life. And so did investment, backed by steady gains in corporate profits. The slowdown in Chinese
property investment, however, will woefully hurt Japan’s exports and leave limited room for cyclical upside from here.
Mainland China: It is still difficult to fathom a blanket easing towards the property sector that is a symbol of wealth
inequality. The debate is on the implications for the financial system of an Evergrande restructuring. We side with those who
think the Chinese government has deep enough pockets to contain the wider repercussions of Evergrande’s saga.
Power stoppage is assumed to alleviate in spring as annual target for energy efficiency resets. Infrastructure spending could
pick up on the back of accelerating the issuance of local government bonds and speeding up project approvals. China’s GDP
growth will hit 5.0% in 2022.
Exhibit 4: GDP Growth and Rates Forecasts
GDP growth (% YoY) Key policy rate (% yearend)
2019 2020 2021F 2022F 2019 2020 2021F 2022F
US 2.2 –3.5 5.3 4.5 1.75–2.00 0.00–0.25 0.00–0.25 0.50–0.75
Eurozone 1.2 –6.8 5.0 4.2 –0.40 –0.50 –0.50 –0.40
UK 1.4 –9.8 7.0 4.6 0.75 0.75 0.35 0.85
Japan 0.7 –4.8 2.0 2.8 –0.10 –0.10 –0.10 –0.10
China* 6.1 2.3 7.8 5.0 4.35 4.35 4.35 4.35
Hong Kong^ –1.2 –6.1 5.8 2.5 5.125 5.000 5.000 5.000
*1-year lending rate, ^Prime rate
Source: Bloomberg, Shanghai Commercial Bank
4Theme#2 The Revenge of Supply
Italian novelist Tomasi di Lampedusa once wrote, “If we want things to stay the same, things will have to change.” At long
last, global leaders – from both side of the political spectrum – are stepping up their efforts to decarbonize the world’s energy
system. But the race to zero carbon emission isn’t an unmitigated blessing. As the saying goes, you can’t make an omelette
without cracking eggs.
Will Green Ambition Translate Into Stagflation?
References to the 1970s become fashionable lately. Stratospheric shipping costs and energy prices resemble what one would
see in a wartime economy. And yet, an uptick in prices often fades almost as soon as a trend seems to emerge. From our
lens, the quirk in energy market doesn’t herald the return of 1970s-style inflation:
• The wild run of energy prices has a different character. The price surge seems burn out quickly (Exhibit 5), rather
than spiraling out of control. What gives? For one thing, the global economy is much less energy-intensive than it was
four decades ago (Exhibit 6). And when the crude price skyrocketed to US$80/barrel, it becomes more profitable to
build up U.S. fracking production – a development that the OPEC tries desperately to avoid.
Exhibit 5: Natural Gas Price (USD per MMBtu)
7
6
5
4
3
2
1
0
2021-04 2021-05 2021-06 2021-07 2021-08 2021-09 2021-10 2021-11 2021-12
Source: CEIC, Shanghai Commercial Bank
Exhibit 6: Energy Use per US$1,000 GDP (kg of Oil Equivalent)
300
250
200
150
100
50
0
1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013
Source: World Bank, Shanghai Commercial Bank
5• Shipping volumes peak each year in mid-October. The lean-and-mean supply chains are caught flat-footed
probably as inventory builds for Christmas. As shown by the swooned Baltic Dry Index, it would be reasonable to assume
peak shipping stress is behind us.
Exhibit 7: The Baltic Dry Index
6,000
5,000
4,000
3,000
2,000
1,000
0
2015 2016 2017 2018 2019 2020 2021 2021-12
Source: Bloomberg, Shanghai Commercial Bank
• It’s not a standalone supply issue. Supply disruption is a misnomer, because it’s instigated by burgeoning demand as
much as capacity constraint. Looking at the PMIs, we see delivery delays in the high-spending U.S. but little elsewhere.
Fiscal stimulus is thus its own worst enemy when it comes to overheating. Hidebound policymaker comes to grips
with the situation. U.S. President Biden vowed that squelching inflation tops policy priority. With slimmed-down fiscal
checks in the year ahead, the worst of the supply bottleneck may be over soon.
The Heat Is on
At its heart, the current drama is the opening gambit of the decade-long transition from brown to green. There’s nowhere to
run, nowhere to hide, what do we do? Here’s our take:
Not all energy crunches are created equal. There had been fears inflation would eat into profit margins. The impact of
inflationary stock is actually far more nuanced than commonly portrayed. If driven by cramped supply, it’s complicated but
this isn’t our focus.
If it is created by rising demand, as appears to be the case now, a surge in oil price should be a legitimate reason for stocks to
beat bonds.
Generally speaking, energy crisis will disproportionately hurt Emerging Market, Japan and Western Europe. Utilities and
consumer industries are other unintended victims. Semiconductor manufacturers, factory automation equipment providers,
and renewable energy all stand to benefit.
Gold glitters. Commodity supercycle chatter will not go away. Monetary austerity at this point is like shutting the barn door
after the horse has bolted. And its physical demand is real as central banks are diversifying into gold. Perhaps crypto is the
most shiny thing at the moment, but we don’t see how committed investor looking for a diversifier can permanently leave
gold. Be wary for its capped upside though, since real yields that are disconnected from economic fundamentals set to right
itself in the second half of 2022.
Volatility strikes back. The New Normal decade of stable growth, below-target inflation, and uneerie calm in volatility is
fading in the rearview mirror. What lies ahead is a brave new world studded with uncertainties, a minefield for policymaker.
U.S. Treasury Inflation-Protected Securities (TIPS), as well as other real assets, make sense to help hedge against tail risks.
6Theme#3 Squeeze Me Gently
Former Fed Chairman Alan Greenspan makes his name in history book by ushering in the concept of the “Fed put”. Over the
ensuing decades, markets have become numb to drastic rate cuts and once-novel asset purchases, in good times and in bad.
The result has been a feverish decline in interest rate, with the U.S. 10-year Treasury pinning to the ground.
Exhibit 8: U.S. 10-year Treasury Yield (%)
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
2010-01 2012-01 2014-01 2016-01 2018-01 2020-01
Source: CEIC, Shanghai Commercial BankExhibit 9: Total Assets (% of GDP)
160%
140%
120%
100%
80%
60%
40%
20%
0%
2008-03 2010-03 2012-03 2014-03 2016-03 2018-03 2020-03
Fed BoJ ECB BoE
Source: CEIC, Shanghai Commercial Bank
Rates should march higher still
The devil was once an angel, too. The Fed, threatened by generational high inflation, is moving deftly into a position to
complete taper by mid-2022.
How much can the yield rise? Every percentage point of Fed QE in terms of GDP worked to reduce 10-year yield by 5bps
(Hamilton 2018). The Fed will have bought US$4.5 trillion, equivalent to 20% of GDP, of Treasuries and MBS by the mid of
2022. So analytically, the Fed’s taper will effortlessly push 10-year yield to above 2%. Empirically, inertia is a powerful force in
policy circles. The Fed waited until the 10-year yield reached 2.25%, before resuming rate hike campaign at the end of 2015.
Analytically sound and empirically grounded, the 10-year yield would probably edge up to the 2% area in 2022.
8Exhibit 10: Fed’s Holdings of Treasuries and MBS (US$ billion)
9,000
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1,000
0
2010-01 2011-01 2012-01 2013-01 2014-01 2015-01 2016-01 2017-01 2018-01 2019-01 2020-01 2021-01
Treasuries MBS
Source: Federal Reserve, Shanghai Commercial Bank
9Rough and Tumble
Like light, liquidity travels everywhere and grow things. But sometimes the light of the candle becomes a fire that sets the
forest ablaze. Few words indeed strike more fear into investors’ minds than tightening.
Before overhauling your portfolio, however, it’s important to put things into perspective:
Deflating your fears over liquidity crunch. 2021 is the year the book “Dow 36,000” turned out to be prophetic. No
wonder there’s a growing drumbeat of calls for an imminent meltdown. We argue that financing conditions may not be as
tight as many seem to think. In the prior hiking cycle, hordes of depositors did not begin rushing into money funds until the
Fed had raised rate to 2.5% (Exhibit 11). The pass-through of rates hikes to savers will similarly be muted this time around, as
retail deposits have since ballooned by trillions. That should allow risk premium to normalize in a discerning way, as the year
progresses.
Exhibit 11: U.S. Retail Deposits (US$ trillion)
20
18
16
14
12
10
8
2013-01 2014-01 2015-01 2016-01 2017-01 2018-01 2019-01 2020-01 2021-01
Source: Federal Reserve, Shanghai Commercial Bank
Tanking bond. Ankle-deep credit spreads would seem at risk. The end of the long-running narrative – white-shoe central
banker will bail out creditors and pump liquidity – is nigh. What’s even more disturbing is the heightened sensitivity of high-
yield bonds to yields due to the all-pervasive barbell strategy. Asset manager will have to pare back risky exposures if they fail
to secure a cheap hedge on high-yield bonds.
10Valuation squeeze. Equity returns can be decomposed into three factors: dividends, earnings growth, and valuation
expansion. Raising rates may cast shadow over dividend policy and corporate profitability, it is however much more tangential
than its impact over the valuation. Even for valuation, which one would expect to be worst affected by tapering, higher yield
seems a headwind, not a firestorm. The linkage between rate and valuation is not particularly strong and is hardly universal
(Exhibit 12).
Exhibit 12: Treasury Yields and S&P500’s Valuation
18
16
14
12
10yr UST (%)
10
8
6
4
2
0
0 5 10 15 20 25 30 35 40 45
S&P500 PE
Source: Wind, Shanghai Commercial Bank
Keep this in mind: Being a doom-monger requires a lot less of probe, so it’s the easiest armor to wear. Over the last dozen
years or so, it’s not exactly been a profitable stance. It’s one thing to judge the cycle is looking a bit long in the tooth, but it’s
another thing to cry for the end. Don’t let perfect be the enemy of good.
11Theme#4 Don’t Fight the Fed
Merely a year ago, global leaders professed cheery confidence in their re-opening plans, and short-dollar trade was once as
consensus as it got. Fate, however, loves irony. The COVID relapsed repeatedly, short-sellers found themselves caught short.
The renewed scramble for the greenback pushed the U.S. Dollar Index out of its nadir in late May. It enjoyed an uninterrupted
renaissance since then.
Exhibit 13: U.S. Dollar Index
105
100
95
90
85
80
2017-06 2017-12 2018-06 2018-12 2019-06 2019-12 2020-06 2020-12 2021-06
Source: Wind, Shanghai Commercial Bank
Dollar doom is now back in fashion. Pundits, proud of their well-honed instincts, reflexively call for a retreat after the dollar
index hits the highest level in more than a year. Is a shock on the way?
12Monetary Policy Back in Driver’s Seat
As Steve Jobs famously said, “you can’t connect the dots looking forward; you can only connect them looking backwards.”
The age-old adage positioning is the enemy of performance is still true. When all the “smart money” is on one side of the
market, there’s a meaningful risk of prices swinging in the opposite direction.
Positioning is not the only thing dollar bear need to worry about. One doesn’t really have to look much beyond the old-
fashioned rate differentials. That’s not just an asterisk compared to the whole story, as some might argue. We know this
from history. Dated back in 2013, it was only after the ECB announced to introduce negative rate that the dollar embarked
upon its meteoric appreciation (Exhibit 14). The ECB, for now at least, seems equally reluctant to accept euro strength. The
ensuing yield advantage should put dollar onto a solid footing.
Exhibit 14: U.S. Dollar Index and Rate Differentials
3.5 105
3.0
100
2.5
95
2.0
1.5 90
Percentage point
1.0
85
0.5
80
0.0
–0.5 75
2013-01 2014-01 2015-01 2016-01 01/2017 2018-01 2019-01 2020-01 2021-01
US-JP rate differential (LHS scale) US-DE rate differential (LHS scale)
US-UK rate differential (LHS scale) USD Index (RHS scale)
Source: CEIC, Shanghai Commercial Bank
This is not to say spread analysis is unblemished. Actually there were weeks characterized by abrupt drops in bond yields
and an unapologetically calm FX market. What happened? The dollar, as a safe-haven currency, tends to strengthen when
uncertainty spikes. The greenback appreciated twice as the economic cycle matured in 2016 and 2019. Odds are that its
counter-cyclical strength will be exacerbated in 2022.
What’s about America’s looming twin budget and current account deficits? The same twin deficits hypothesis was invoked
before the pandemic. The dollar didn’t collapse then, without fresh catalyst, there’s good reason to doubt it will collapse
now.
Mix and Match
While a gentle dollar strength is expected to be a constant theme over the coming months, it’s not black and white as
commonly portrayed. The reality is more nuanced. Foreign exchange, after all, is a market of many.
13How to think about FX market
The EUR will continue to struggle for buoyancy. Consumed by a stagflationary
EUR Overweight
fear, ECB President Lagarde, clinging to her bureaucratic root, pledged not to
repeat the same mistakes that Trichet made by tightening in July 2008. COVID
Neutral
resurgence, French election, and conflict with Russia can all be cited as reasons for
EUR underperformance. Shorting EUR might once again come on the radar screen
Underweight
of speculators.
Cyclical factors is positive for the pound. The decade-high inflation will keep BoE
GBP Overweight
tightening prospects on the front-burner. But London is not without its own
problem. Another year of toxic Brexit negotiations would derail its flimsy recovery.
Neutral
On a comforting note, the current Brexit deal is only marginally better than no
deal, so its failure is unlikely to induce the kind of volatility witnessed in 2019.
Underweight
The Renminbi has steadily ascended towards the levels unseen since the 2015
RMB Overweight
reform. Its resilience, despite China’s stalling growth momentum, is underpinned
by record-breaking exports and trimmed outbound tourism flows. This strength
Neutral
is slowly receding amid re-opening and hence becomes an area of vulnerability.
When the one-way traffic becomes two-way, its attractiveness for carry traders
Underweight
will be compromised further.
Yen has handily been the worst-performing major currency in 2021. Still
JPY Overweight
haunted by the devastating deflation, the BoJ remains reluctant to dial back
accommodation when its peers embark for on tightening cycle. Yen should remain
Neutral
on the back foot due to glaringly huge yield spread. Bereft of artificial boosts like
renewed rounds of QE and GPIF’s overseas investment, its controlled depreciation is
Underweight
unlikely to ruffle BoJ’s feathers.
While its high-beta bent is a reason for optimism, the steel-heavy composition
AUD Overweight
of Australian export basket makes it a less than ideal expression of rising energy
prices compared to CAD. The amount of rate hikes priced-in will also be a hurdle
Neutral
for meaningful AUD strength. At current levels though, it is simply not stretched
enough to make the risk-reward of entering fresh AUD shorts compelling.
Underweight
Further recovery in global trade sets a constructive tone for the kiwi. As long as the
NZD Overweight
RBNZ remains at the forefront of hawkish guidance, the kiwi would be supported
by carry flows, though position squaring will bring some volatility. The wild card is
Neutral
its housing market, which is more fragile than it looks.
Underweight
>1% within 3 months
±1% within 3 monthsExhibit 15: Foreign Exchange Outlook
Yearend target
Current 2021F 2022F
EUR/USD 1.13 1.13 1.10
GBP/USD 1.32 1.33 1.31
USD/JPY 114 114 117
USD/CNH 6.38 6.40 6.55
AUD/USD 0.71 0.72 0.74
NZD/USD 0.68 0.70 0.71
Source: Bloomberg, Shanghai Commercial Bank
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Investment Risk Disclosure (Continued)
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172022 Global Economic and
Foreign Exchange Outlook
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