Economic and market outlook 2022 - Mercer Canada
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Economic and market outlook 2022
Economic and market outlook 2022 2
The COVID-19 crisis dug a deep economic supported by wage growth and generally higher inflation
expectations.
hole in 2020. In 2021, that hole was filled
in. In practice, the recovery has not been The year ahead is interesting from an inflation dynamic
as straightforward as that metaphor might perspective. Although we believe the underlying pressures
will persist, headline year-on-year rates should fall because
suggest. The reimposition of restrictions of base effects.1 On a longer-term average basis (which
across many large economies weighed ignores base effects), inflation is likely to be higher than it
on global growth during the first quarter has been for some time, especially in the US and the UK,
while moving up toward target in the eurozone and rising
of the year. While some restrictions slightly in Japan.
remained in place, countries began to
vaccinate their populations, leading to In 2020, monetary and fiscal policy worked in tandem
to help the global economy withstand strict lockdown
a step-by-step return to normality. The measures. 2021 saw a broad continuation of that, with
economic reopening unleashed huge pent- governments willing to spend and central banks remaining
up demand, leading to a strong pickup in broadly accommodative. As the year end approached, a few
central banks started to withdraw their support measures
economic activity. Although some of that as their policy objectives were increasingly met. The Bank
economic momentum was lost going into of England was particularly hawkish, while the US Federal
the end of the year on the back of supply- Reserve (the Fed) remained quite balanced (trimming its
asset purchase program while delaying rate hikes).
chain disruptions, high energy prices and The European Central Bank and the Bank of Japan retained
weaker growth in China, we believe 2022 their broad support measures.
should see the economic recovery continue.
2022 should be a year when more of the emergency
monetary policy measures of 2020 are unwound, while
fiscal policy remains supportive (although compared to
Back to the metaphor: If 2021 was the year when the hole 2021, it will be tighter). If communicated well, it should
was filled, 2022 should see building work commence on the not upset risk markets too much, and if done gradually, it
freshly leveled ground. In economic terms, we expect the should not upset the broad economic outlook either.
global economy to recover to where it would have been
had the virus never hit, and in some cases, to grow even Equity markets have had a very strong 2021, as the
beyond that. Strong income growth, coupled with healthy economic reopening supported earnings growth and
consumer balance sheets, should support consumption. discount rates remained low, especially in real terms.2
We are also seeing encouraging signs on the investment The positive headline performance masks the evolving
front, with businesses engaging in capital-intensive themes of the year, with numerous rotations taking
projects. Governments are not planning to tighten their place between equity factors. Although the fundamental
belts as aggressively as they did in the wake of the global backdrop is supportive for earnings, stretched valuations
financial crisis, with government spending and investment and some clear signals of market froth make our overall
set to remain elevated. All of that creates a positive view on equity markets more neutral. We do see
macroeconomic backdrop for the year ahead. value opportunities within equities, for example, in
emerging markets.
Inflation has picked up sharply, driven by significant base
effects, reopening price pressures, disrupted global supply Nominal bonds have had a volatile year, selling off sharply
chains and much higher commodity prices. Although some at the start of 2021 as inflation and growth picked up.
of these effects are temporary in nature and should fade The mid-year saw bond prices rally on the back of
over the medium term, inflation should continue to be
1
The low price level in 2020 means that when prices normalize in 2021, they rise by a lot on a year-on-year basis. That is a base effect
increasing inflation. High prices in 2021 mean inflation is likely to fall in 2022 because of base effects working the other way.
2
Inflation adjusted.
© 2021 Mercer LLC. All rights reserved.
2022
Economic and market outlook 2021 3
supportive technical factors and growth concerns, amid One of the key risks to financial markets is a policy mistake
intensifying supply chain pressure and some concerns by a central bank. For example, take a situation where
about the potential demand impact of another coronavirus higher inflation persists and the Fed does not increase
variant. The theme of inflation took center stage going into interest rates. That could lead to inflation expectations
the end of the year, leading to yet another selloff in nominal becoming unanchored, which would then force the Fed to
bonds. On a real-yield basis, bonds have not sold off much, aggressively tighten policy and likely cause a recession.
in fact they rallied in some countries. We expect bond yields We believe the Fed is running that risk now, as inflation (and
to edge higher (or prices to move lower) as economies average inflation) is clearly elevated, growth is robust, yet
recover and inflationary pressures persist. the Federal Open Market Committee is communicating only
a gradual path of monetary policy normalization.
Credit markets have had a reasonably dull year, with
spreads3 tightening modestly. The biggest driver of return Another key risk is the emergence of another variant of the
over the year was duration. Investment-grade corporate coronavirus, overcoming the defense offered by currently
bonds, with their higher durations, underperformed sub- available vaccines. In this scenario, countries may have to
investment-grade corporate bonds, which have much reimpose lockdown measures until vaccines are updated.
lower duration and higher yield. Our outlook on duration
is broadly negative, while our outlook on credit spreads is The longer current supply chain disruptions persist,
relatively benign. Although spreads are already at low levels, the bigger the risk they pose to the broader economic
we believe they should stay tight, as economic recovery, outlook. What do we mean by “disrupted supply chains”?
coupled with healthy corporate balance sheets, should Some countries are still constrained in their production,
lead to limited default/downgrade activity, offering credit affecting just-in-time manufacturing. The cost of shipping
investors a reasonable carry return. has skyrocketed to multiples higher than normal levels.
Booming consumer demand has led to very low business
Both hard- and local-currency emerging markets debt inventory levels. In short, people want goods, but there
struggled in 2021. The former was dragged down by a are not enough to go around, and moving them is proving
selloff in developed markets duration, while the latter especially troublesome. That weighs on growth and creates
struggled because of the appreciating US dollar and rising inflationary pressures. Although we expect these distortions
inflation in much of the world. The outlook for local- to be temporary in nature, they seem to be dragging on for
currency emerging markets debt is broadly positive, as local longer than the market expected.
currencies are cheap versus the US dollar. The outlook for
hard-currency debt is positive on the spread, but negative The US–China geopolitical tensions persist and we believe
on the overall return profile because of its exposure to continue to pose a risk to financial markets. Although
developed markets duration. we do not expect a Trump-like trade war between the
world’s two largest economies, we expect frictions along
The US dollar has had a strong year because of strong US technology and regional military influence fronts to persist.
growth and higher US bond yields. Its major counterparts, Taiwan–China relations are particularly tense, which could
the euro and the Japanese yen, struggled. Emerging lead to bouts of market volatility. Generally, we do not
market currencies sold off over the year on the back of expect geopolitical developments to have any long-lasting
less favorable COVID-19 dynamics on the back of slower effects on financial markets, but we are aware that lots of
uptake of vaccinations. 2021 saw a sharp rally in commodity geopolitical factors are largely unforecastable. There are
prices as booming global demand overwhelmed available also risks emanating from inside China, in terms of further
supply. The year also saw substantial rallies in alternative regulatory crackdowns.
assets, such as cryptocurrency. We expect the US dollar
to depreciate modestly, against both developed market
currencies and emerging market currencies.
3
The difference in yields between a corporate bond and a duration-matched government bond.
© 2021 Mercer LLC. All rights reserved.
Economic and market outlook 2022 4
What happened in 2021?
The global economy continued to recover from what was Central banks continued their support measures,
one of the sharpest and deepest recessions in history. underpinning very easy financial conditions. In other words,
Although COVID-19 remained a factor, its impact was less it was easy to borrow, and banks and bond markets were
than that felt in 2020. This is because lockdown measures eager to lend, which aided both business and consumer
were not as indiscriminate in large, developed economies, sentiment. Governments remained supportive too,
with restrictions mostly focused on the services sector. extending numerous crisis response measures, such as
Furthermore, many countries rolled out their vaccination income support in the US and furlough measures in the
programs, which slowly but firmly reduced hospitalizations, UK, before paring them back in September as labor
serious illness and death. markets recovered.
Not all countries had equal access to vaccines, and not The reopening (albeit not uniform globally), coupled with
all countries moved at an equal pace (e.g., by June 30, supportive policy measures, helped the global economy
2021, the US had vaccinated about half of its population, grow strongly during the second and third quarters,
whereas Japan had only vaccinated about 12%,4 see Figure continuing down the path toward full recovery.5 Economic
1), instead relying on a strict lockdown approach to counter momentum slowed somewhat into the fourth quarter, as
rising cases. That led to divergent global recoveries. The central banks engaged in less supportive rhetoric, energy
US, Europe and other regions with highly vaccinated prices spiked, supply chains got stretched and China slowed
populations have reopened, which has led to a sharp amid its regulatory crackdown.
pickup in economic activity. Much of Asia-Pacific, such as
Japan, Australia, China and a number of emerging market One of the biggest topics, and arguably one of the key
countries where populations were not as well vaccinated, market drivers of the year, was inflation. It picked up sharply
have chosen to reimpose restrictions, therefore in a number of economies (especially in the US) because of
lagging behind. base effects,6 high consumer demand, higher commodity
prices and disrupted supply chains adding to the pressure
on goods prices.
4
Source: Bloomberg.
5
Full recovery is getting back to where an economy would have been had the virus never hit.
6
Prices were very low a year ago because of the crisis; returning to more normal prices now leads to a large rise in year-on-year inflation.
© 2021 Mercer LLC. All rights reserved.Economic and market outlook 2022 5
Figure 1. Vaccination drive
80%
70%
% of population fully vaccinated
60%
50%
40%
30%
20%
10%
0
Jan 21 Feb 21 Mar 21 Apr 21 May 21 Jun 21 Jul 21 Aug 21 Sep 21 Oct 21
US Japan Eurozone* EM avgerage** UK
Source: Bloomberg as of October 26, 2021.
*EZ is average vaccination rate of Germany, France, Italy, Netherlands and Spain.
**EM is average vaccination rate of Brazil, Mexico, Taiwan, India, Russia, South Africa and China.
Percent of population fully vaccinated against COVID-19. Data is collected by Bloomberg News from multiple sources. As the reporting
process for vaccine data is developed, there may be differences between total counts, depending on source type and methodology.
© 2021 Mercer LLC. All rights reserved.Economic and market outlook 2022 6
What do we think will
happen in 2022?
We are broadly positive on the economic outlook. Strong we believe that the global economy is well on track to
income growth coupled with healthy consumer balance recover to where it would have been had the virus never
sheets should support consumption. We are also seeing hit and perhaps even to exceed that level. Virus-related
encouraging signs on the investment front, with businesses restrictions and energy price spikes might weaken growth
engaging in capital-intensive projects. Governments, unlike for a couple of quarters, but we expect growth to recover
after the global financial crisis, are not planning to tighten after things normalize, returning economies to their original
their belts anytime soon, with government spending and trajectories toward full recovery (see a model example in
investment set to remain elevated. Against this backdrop, Figure 2).
Figure 2. Recovery model example for developed economies
110
Full recovery point
105
Indexed GDP, Dec 31 2019=100
100
Stage 3, fundamental recovery
Stage 2, vaccine recovery
95
Stage 1, pickup in growth
because of the reopening
90
Dec 19 Jun 20 Dec 20 Jun 21 Dec 21 Jun 22 Dec 22 Jun 23 Dec 23
Trend 2% Actual No permanent damage If permanent damage Permanent gain
Source: Mercer, illustrative purposes only.
The trend light blue line illustrates where the economy would have been had the virus never hit. The gray line shows the actual path of
GDP. The gray dotted line shows a scenario where the economy recovers without permanent scarring. The purple dotted line shows a
scenario with permanent scarring. The blue dotted line shows a scenario where the economy is fully above where it would have been
had the virus never hit.
© 2021 Mercer LLC. All rights reserved.Economic and market outlook 2022 7
Figure 3. Headline inflation forecast
Inflation Q1-21 Q2-21 Q3-21 Q4-21 Q1-22 Q2-22 Q3-22 Q4-22
US 1.9% 4.8% 5.3% 5.6% 5.2% 3.7% 2.7% 2.4%
UK 0.6% 2.1% 2.8% 4.5% 4.5% 4.7% 4.1% 2.8%
Eurozone 1.1% 1.8% 2.8% 3.7% 2.7% 2.4% 1.8% 1.3%
Japan -0.5% -0.7% 0.0% 0.7% 0.5% 1.4% 1.3% 1.2%
China -0.1% 1.2% 0.6% 1.4% 1.1% 1.0% 1.6% 1.8%
EM ex China 4.4% 5.5% 5.9% 5.9% 5.6% 4.9% 4.3% 4.2%
Figure 4. Core inflation forecast
Core inflation Q1-21 Q2-21 Q3-21 Q4-21 Q1-22 Q2-22 Q3-22 Q4-22
US 1.4% 3.7% 4.1% 4.5% 4.8% 3.4% 2.7% 2.5%
UK 1.1% 1.9% 2.6% 3.9% 4.2% 4.3% 3.5% 2.5%
Eurozone 1.1% 0.9% 1.4% 2.2% 1.6% 1.9% 1.5% 1.2%
Japan -0.5% -0.6% 0.0% 0.7% 0.5% 1.4% 1.3% 1.2%
China 0.3% 0.9% 1.1% 1.2% 1.5% 1.2% 1.3% 1.3%
EM ex China 5.3% 5.8% 6.0% 5.9% 5.3% 5.0% 4.9% 4.9%
Figure 5. Growth forecast
Growth Q1-21 Q2-21 Q3-21 Q4-21 Q1-22 Q2-22 Q3-22 Q4-22
US 6.3% 6.7% 4.0% 3.5% 3.5% 3.0% 2.5% 2.3%
UK -5.3% 23.9% 6.0% 5.2% 3.2% 2.4% 2.0% 1.8%
Eurozone -1.1% 9.2% 8.5% 3.5% 4.0% 5.0% 4.5% 4.0%
Japan -4.2% 1.9% 1.0% 8.5% 6.0% 1.0% 0.8% 0.8%
China 5.1% 4.1% -3.3% 5.0% 5.0% 7.0% 5.5% 5.5%
EM ex China 6.3% 0.7% 2.0% 5.6% 4.5% 5.3% 4.7% 4.7%
The numbers are seasonally adjusted annual rate.
Figure 3-5 source: Goldman Sachs.
Forecast from Q3 2021 onwards.
© 2021 Mercer LLC. All rights reserved.Economic and market outlook 2022 8
On the subject of inflation, this is partly caused by transitory margins, which leads to consumers demanding higher pay
factors; however, some of it is not, and by the time these in their jobs, creating a self-enforcing cycle of underlying
factors fade, there may be other inflationary forces to deal price pressures. While we expect this environment to persist,
with, principally, wage growth driven by tight labor markets. we do not expect inflation to get out of control like it did
We are seeing plenty of signs that companies are struggling in the 1980s (see Figure 6.1 for inflation expectations
to hire and are raising or planning to raise compensation which are higher but broadly contained for now). Current
(see Figure 6, which illustrates how a tight labor market inflation dynamics have important policy implications, which
leads to wage pressures in the US). Higher wages mean we will discuss in a separate section.
businesses need to increase their prices to protect their
Figure 6. US labor market
50 45
40 40
30 35
20
30
10
25
0
Index
Index
20
-10
15
-20
10
-30
-40 5
-50 0
-60 -5
Dec 01
Dec 02
Dec 03
Dec 04
Dec 05
Dec 06
Dec 07
Dec 08
Dec 09
Dec 10
Dec 11
Dec 12
Dec 13
Dec 14
Dec 15
Dec 16
Dec 17
Dec 18
Dec 19
Dec 20
Jobs plenty ― jobs hard to get* Small business compensation (RHS)
Source: Bloomberg as of October 26, 2021.
* a random household is asked two questions: do you see plenty of
jobs available? Do you find it difficult to find a job? The answers are
aggregated and respective index series are produced. We take the
difference between the two series to understand how well or how
badly the labour market is doing.
© 2021 Mercer LLC. All rights reserved.Economic and market outlook 2022 9
Figure 6.1. US headline inflation expectations, 5-year
3.6%
3.4%
3.2%
3%
2.8%
2.6%
2.4%
2.2%
2%
2003
2020
2000
2001
2002
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
Source: Bloomberg as of October 26, 2021.
Sustainability is at the forefront of
institutional decision-making.
Investors increasingly incorporate ESG principles in their
stock/fund selection process and they are making long term
commitments to decarbonize their portfolios. Financial
markets continue to evolve, together with numerous
sustainability-aware investments gaining popularity both in
private and public space. For example, the UK government
has recently issued ‘green gilts’. Although we expect this
trend to continue and drive important conversations
and decisions over the medium term, the impact of
sustainability over 2022 is likely to be fairly limited on
overall market direction, but will continue to impact investor
preference and single stock/bond movements.
© 2021 Mercer LLC. All rights reserved.Economic and market outlook 2022 10
Regional outlooks
United States
The US economy cruised through 2021 and is set to expand vaccination program as soon as possible. As we write,
by just over 5%.7 Unlike its developed counterparts, the US approximately 57%8 of the total population has been
did not impose major restrictive measures at a federal level, vaccinated, allowing hospitalization and death rates to be
but certainly did at a state and local level. Instead, broadly contained (see Figure 7).
the federal government focused on rolling out the
Figure 7. 30D change in deaths as a % of populations
0.07%
0.06%
30 day change in deaths as a % of populations
0.05%
0.04%
0.03%
0.02%
0.01%
0.00%
Jul 21
Jan 21
Jun 21
Oct 21
Feb 21
Apr 21
Sep 21
Mar 21
Aug 21
May 21
Jul 20
Jan 20
Jun 20
Oct 20
Feb 20
Apr 20
Sep 20
Dec 20
Mar 20
Aug 20
Nov 20
May 20
US Japan EZ* China EM ex China** UK
Source: Bloomberg.
*EZ is Germany, France, Italy, Netherlands and Spain.
**EM ex China is Brazil, Mexico, Taiwan, India, Russia and South Africa.
7
Source: Goldman Sachs economic forecasts, October 2021.
8
The number is skewed toward older and more vulnerable people. Source: Bloomberg, 25 October 2021.
© 2021 Mercer LLC. All rights reserved.Economic and market outlook 2022 11
The US Democratic Party, after two unlikely wins in January’s even as elevated government spending this year weighs on
Georgia runoff elections, gained control of the Senate, albeit next year’s growth data.10
by the thinnest of margins.9 That has allowed President
Biden to push his agenda forward, announcing substantial Inflation in the US is a highly pertinent issue. It has risen
fiscal stimulus measures designed to increase investment in sharply and is forecast to finish the year at 5.6%11 while
both human capital and physical infrastructure. Currently, the measure that excludes the volatile items of food and
these measures are in their final stages of approval. energy is at 4.5%12 (see Figures 3 and 4). Clearly, inflation is
above the rate targeted by the Fed and it is not necessarily
A more regionalized and pragmatic approach to restrictions, all transitory. In fact, price pressures have broadened
coupled with supportive fiscal stimulus measures and recently, with the shelter component of the inflation basket
accommodative central bank measures underpinned also on the rise. Input cost inflation is showing few signs
strong economic activity in 2021. Going forward, following of subsiding too, with energy prices elevated and wages
a modest softening in data toward the year-end, we think on the rise. Companies are struggling to hire, people are
the US economy is well on track to recover to where it would quitting their jobs at a record pace, and both employees
have been had the virus never hit and perhaps beyond. and prospective employees are all demanding higher pay
Consumption should be well supported by income growth (see Figure 7.1 for wage trackers). Importantly, companies
(plenty of jobs, rising wages) and positive balance-sheet have shown both a willingness and an ability to pass on
effects (high savings, which should support spending). these input cost pressures to the end consumer. We expect
Investment is booming, with businesses, encouraged by this theme to continue, underpinning the broader inflation
easy financial conditions, committing to capital-intensive rate (even though we expect it to fall in 2022 because of
projects. This creates a positive macroeconomic backdrop, base effects) and prompting monetary policy changes.
Figure 7.1. Wage tracker
5%
4%
3%
Wage Growth YoY (%)
2%
1%
0%
-1%
Apr 21
Aug 21
Apr 11
Aug 11
Dec 11
Dec 10
Apr 12
Aug 12
Dec 12
Apr 13
Aug 13
Dec 13
Apr 14
Aug 14
Dec 14
Apr 15
Aug 15
Dec 15
APr 16
Aug 16
Dec 16
Apr 17
Aug 17
Dec 17
Apr 18
Aug 18
Dec 18
Apr 19
Aug 19
Dec 19
Apr 20
Aug 20
Dec 20
US Japan Eurozone UK
Source: Goldman Sachs as of October 26, 2021.
9
50–50 split between Democrats and Republicans with the Vice President having a casting vote in the event of a tie.
10
Positive impact on growth now because of elevated government spending means a negative impulse on growth tomorrow. This is called a negative fiscal impulse.
11
Broad CPI year-on-year measure. Source: Goldman Sachs, October.
12
Source: Goldman Sachs, October.
© 2021 Mercer LLC. All rights reserved.Economic and market outlook 2022 12
Eurozone hand cars. On balance, while eurozone inflation is being
lifted by global price pressures, domestic inflation is largely
In comparison, the eurozone did not do as well in 2021 as subdued, and there is little evidence of significant wage
the US, mostly because it was a bit slower to roll out its growth pressures. As in the US/UK, 2022 should see inflation
vaccination program. The ensuing restrictions were not as decelerate somewhat, because of base effects.
severe as those imposed a year ago, but they weighed on
growth nevertheless. As the pace of vaccinations picked up United Kingdom
and restrictions were gradually lifted, economies rebounded
over the European summer, with some moderation into The UK, similar to its developed counterparts in Europe,
year end. locked down again early in the year and reopened in the
spring. Its GDP dynamics reflect that, with growth shrinking
One of the few silver linings of the COVID-19 pandemic was by 5.3% SAAR in Q1 and bouncing back 23.9% in Q2 and
the establishment of the European Recovery Fund. This is 6.0%16 in Q3 (see Figure 5). It also emphasizes a very
the first time the EU has engaged in a fiscal transfer exercise important point: Lockdowns largely delay growth, they do
that is funded by commonly issued debt, aiding countries not eliminate it, especially if fiscal policy is able to loosen
most in need (e.g., Italy). Although it is unlikely to be a in response to any restrictive measures. The last quarter
permanent tool like the regular interstate fiscal transfers in of 2021, although positive, was a bit softer because of the
the US, it does establish an important precedent for future energy crisis, supply-chain disruptions, labor shortages and
crises, taking some weight off the shoulders of the European the China slowdown weighing on macro-sentiment. Going
Central Bank. forward, the UK is in decent shape to continue its path
toward full recovery.
2021 marked the end of an era in German politics, with
Chancellor Angela Merkel departing the political stage One big uncertainty for the UK is the extent of the ongoing
after more than 20 years of leadership. What is next? disruption caused by Brexit, as businesses readjust to the
Her successor is most likely to be the leader of the Social new reality and new terms of trade. Because the exit from
Democratic Party (SDP) — Olaf Scholz, who is currently the European Union and the arrival of COVID-19 overlapped,
in coalition negotiations following a close election win in it is very difficult to disentangle the two and determine the
September. We believe that the coalition between the SDP, impact that the new trading relationship has had on the UK
Greens and Free Democrats (leaving the incumbent Merkel’s economy. Ongoing squabbles with the EU over Northern
party out of power) would be more fiscally expansive, Ireland and shipping rights are another source of uncertainty
creating a positive macroeconomic backdrop for the whole and pose short-term risks to trade.
region. However, we do not expect it to be a major game-
changer, because of the difficulty in getting policy measures Inflation in the UK is high, as measured by the Consumer
passed through both chambers of the German Parliament.13 Price Index, which is set to hit 4.5%17 by year end (core
forecast to hit 3.9%18 ) (see Figures 3 and 4). Wages are
A strong 2021 should be followed by a strong 2022, as rising too across most income spectrums, creating input
European economies get back to normal and the policy mix cost pressures that are more permanent in nature. Brexit
remains accommodative. In terms of growth, in 2022, we do created a dynamic whereby labor from Europe can no longer
not expect the economy to get back to where it would have freely enter the UK for low-paid jobs and either there is not
been had the virus never hit, but we think it will continue to enough local labor force to fill those jobs, or the reservation
make up lost ground. wage is much higher. The shortages of truck drivers and
seasonal workers are just two examples of this. This means
The eurozone did not escape the broad price pressures, with that the unemployment rate at which wages are starting to
headline inflation forecast to finish 2021 at 3.7%14 rise may be higher than it was pre-Brexit, adding to inflation
(see Figures 3 & 4) and the measure that excludes the pressures. 2022 should see inflation decelerate because
volatile food and energy prices projected to rise to 2.2%.15 of base effects, but we expect the underlying pressures to
Some of this is driven by base effects and some of it by persist, prompting monetary policy actions.
temporary increases, such as in energy prices and second-
13
For example, in order to get rid of the so-called “debt brake,” you would need a two-thirds majority in both
chambers of the German parliament. Difficult to achieve with a thin ruling coalition.
14, 15, 17, 18
Year-on-year inflation measure, forecast for the 4th quarter. Source: Goldman Sachs.
16
GDP data is sourced from J.P. Morgan.
© 2021 Mercer LLC. All rights reserved.Economic and market outlook 2022 13
Japan We do not expect the current soft patch of growth to
persist long into 2022, and we anticipate the economy to
Japan’s COVID-19 policy differed from that adopted by recover as policy measures turn a bit more stimulative.
the US, UK and Europe. There were no restrictions on The US–China frictions persist on numerous fronts,
movement, while bars and restaurants were encouraged, and we expect economic and political decoupling to
but not forced, to close early. Nevertheless, people adjusted continue. Regulatory risks remain ahead of the politically
their behavior regularly, based on perceived virus trends. important National Congress of the Chinese Communist
Fiscal transfers were also relatively limited, while monetary Party in late 2022. While these actions may have negative
policy was not eased further during the recession. The consequences for certain sectors of the economy, we do
economy shrank in Q1 and rebounded modestly in Q2, not believe this signals a shift in the strategic objectives of
before shrinking again in Q3. The end of the year is looking Chinese policymakers, nor a deprioritization of economic
stronger because of the recent reopening (see Figure 5). development. Rather, the actions seek to strengthen the
economy by preventing concentration of market power,
We expect a strong start to the year, as high vaccination and encouraging capital and labor to be allocated toward
rates will finally allow Japan to experience its first post- productivity-enhancing uses, with the ultimate aim of
COVID boom in consumption. Numbers should soften after enabling China to become an advanced economy. While
that but continue to be supported by strong capex and these steps may be positive over the long term, they are not
a strong labor market. Japan is the only major economy without risk in the short term.
expected to grow more strongly in 2022 than 2021.
Nevertheless, Japan may struggle to get back to where it In a similar vein, the crackdown on the property sector can
would have been had the virus never hit. Fiscal stimulus be viewed as an attempt to reduce vulnerabilities within
is expected to be announced after the autumn lower- the economy. Housing affordability is very low in tier-1
house elections, but little is known about the potential cities. Meanwhile, strict rules to cap property developers’
composition of borrowing — “the three red lines” — were introduced in
that package. late 2020, prompting them to deleverage, pushing some
developers into stress and leading to an economy-wide
Similar to Europe, Japanese inflation has risen from low slowdown in housing starts and residential sales growth.
levels because of global pressures, but domestic price Given property is directly and indirectly estimated to
pressures remain muted. The headline inflation rose slightly contribute approximately 30% of China’s GDP growth, these
and is forecast to finish the year at 0.7%,19 core at 0.7%20 efforts will weigh on growth in the near term. However,
(see Figures 3 and 4) which is well below the central bank policymakers are keen to prevent this getting out of
target. We struggle to see the dynamic changing and hand, and in late 2021 have been encouraging banks to
believe inflation will remain muted for a while to come, 2022 loosen household lending standards, while retaining tight
at the very least. conditions for developers. It appears that policymakers
may be attempting to engineer a transfer of liabilities from
Emerging economies highly leveraged property developers to households, while
at the same time, preventing froth from emerging in the
China is the first country to recover to where it would have housing market. With multiple, potentially competing,
been had the virus never hit. Like much of the APAC region, objectives in the housing sector, the risk of a policy error
Chinese authorities opted for a zero-COVID-19 tolerance- is real. However, we expect any problems to be contained,
policy. That meant any outbreak was met with very strict given that banks are well capitalized, and housing
regional lockdown measures — a dynamic enforced in 2021 inventories and leverage are modest.
and weighing on growth numbers. Economic activity was
further dampened by a regulatory crackdown, with Chinese Growth in the emerging world ex-China is buffeted by the
authorities targeting certain sectors of the economy same factors as most other countries; lockdowns mean a
(technology, property, education) under the banner of bad quarter, reopening means a good quarter. Compared
“common prosperity.” to developed markets, however, the vaccination campaign
19, 20
Year-on-year inflation measure, forecast for the 4th quarter. Source: Goldman Sachs.
© 2021 Mercer LLC. All rights reserved.Economic and market outlook 2022 14
has not been as aggressive and more restrictions were
imposed. Our outlook on emerging economies ex-China is
constructive, assuming vaccination programs gain critical
mass; however, we do acknowledge the headwinds coming
from the monetary policy of tighter developed markets.
Inflation in the emerging world is hard to generalize.
Some countries with prudent monetary policies keep it well
managed, some don’t. Some countries are more exposed
to commodity prices, some less. Broadly, inflation in the
emerging world ex-China has risen and is set to finish the
year at 5.9%.21 Inflation in China is set to finish the year at
a relatively low rate of 1.2%22 (see Figures 3 and 4). We will
touch on that more in the Monetary Policy section.
21, 21
Year-on-year inflation measure, forecast for the 4th quarter. Source: Goldman Sachs.
© 2021 Mercer LLC. All rights reserved.Economic and market outlook 2022 15
Global central bank outlook
Faced with a crisis of unprecedented scale in 2020, central The US Federal Reserve has a dual mandate. It works to
banks reacted aggressively, slashing interest rates to ensure price stability, which, as per the latest monetary
historically low levels, announcing numerous credit-easing policy review, is defined as average inflation targeting. That
policies and increasing the size of quantitative easing means when inflation runs below 2% for a few years, the Fed
measures. The ultra-loose monetary policy did its job by will tolerate an overshoot for the next few years. The Fed
creating very easy financial conditions which have been also aims to achieve full employment. On the price stability
instrumental for the economic recovery. While that persisted front, whichever way you slice it, the Fed has achieved it (see
for most of 2021, the conversation shifted from “ultra-easy” Figure 8 that demonstrates how current core inflation
towards “planning for tightening” in the first half of the year is above target on three- and five-year averages). On the
and “actually tightening” towards the end of the year. full-employment front, although the unemployment rate is
still above where it was pre-crisis, there is plenty of evidence
Sharply rebounding growth, increasingly tight labor that the labor market is tight, creating significant wage
markets, elevated inflation and inflation expectations pressures. Against this backdrop, we believe the Fed will
do not create an environment for ultra-easy monetary tighten its monetary policy by tapering asset purchases and
policy, and failing to react in a timely manner could raising the policy rate in late 2022. We believe the tightening
create issues of its own. Of course, not all regions are in cycle will be slightly more aggressive than is currently priced
the same situation and not all central banks have in by the market (see Figure 9 for short-term bond yields
equal mandates. that are heavily driven by the central bank’s policy rate).
© 2021 Mercer LLC. All rights reserved.Economic and market outlook 2022 16
Figure 8. US core inflation % (CPI)
6%
5%
4%
Annual Inflation Rate (%)
3%
2%
1%
0%
-1%
-2%
-3%
Dec 00
Dec 01
Dec 02
Dec 03
Dec 04
Dec 05
Dec 06
Dec 07
Dec 08
Dec 09
Dec 10
Dec 11
Dec 12
Dec 13
Dec 14
Dec 15
Dec 16
Dec 17
Dec 18
Dec 19
Dec 20
Core Average target 5-year average 3-year average
Source: Goldman Sachs as of October 26, 2021.
The Bank of England, unlike its counterpart in the US, only With inflationary pressures more muted in the eurozone,
aims to achieve 2% inflation as measured by the Consumer we do not expect the European Central Bank to tighten its
Price Index. With it running hot right now, and with monetary policy, with the only exception being a reduction
inflationary pressures seeming much more persistent and in the crisis-only pandemic asset purchase program.
broader than previously thought, the Bank of England has The Bank of Japan, faced with little inflation and a mixed
signaled very clearly that it will be hiking rates soon. We growth outlook, is likely to continue with its asset purchase
believe that is timely, and we believe that the market fairly program and negative interest rates for a while to come —
reflects the path of tightening going forward (see Figure 9). certainly for the whole of 2022 in our view.
© 2021 Mercer LLC. All rights reserved.Economic and market outlook 2022 17
Figure 9. 2-year government bond yields
3.5%
3%
2.5%
2%
1.5%
1%
0.5%
0.%
-0.5%
-1%
Dec 13 Dec 14 Dec 15 Dec 16 Dec 17 Dec 18 Dec 19 Dec 20
US 2-year Japan 2-year Eurozone 2-year UK 2-year
Central banks in a number of emerging market countries Not all are the same of course, with East Asian central
have started to increase interest rates, mostly because of banks retaining a broadly accommodative stance. As the
higher commodity prices and less ability and willingness to vaccination drive allows economies to reopen and economic
view price increases as temporary. We believe these moves activity to get back to normal, we expect more and more
are prudent. They reduce the risk of high inflation and build central banks to tighten their monetary policies.
protection for their currencies and their external balances.
© 2021 Mercer LLC. All rights reserved.Economic and market outlook 2022 18
Markets
Equities
2021 has been a great year for developed market equities, 2021 earnings jumped sharply and have surprised on
which rallied by approximately 19%23 year-to-date. However, the upside, both in developed and emerging markets.
it has in no way been a quiet year, with numerous stories Rebounding economic activity, coupled with still-easy
playing out within the asset class. The first few months financial conditions, certainly helped. While input cost
of the year could be classified as “reflation”; that is, an inflation did create some margin pressures going into the
environment of high growth and accelerating inflation, an year end, companies have so far been good at passing
environment where low-duration assets perform better than increases on to the consumer.
high-duration assets. In equities, that meant companies
whose cash flows are sooner rather than later. In factor Emerging market companies struggled on a relative basis,
terminology, value stocks did better than growth stocks. dragged down by Chinese equities. China’s regulatory
crackdown, coupled with its COVID-19 lockdown measures
The growth-into-value rotation stopped around and the appreciating US dollar weighing on investor
summertime, amid the Delta variant concerns and the sentiment. Ex-China emerging markets did modestly
market repricing its expectations for tighter central bank better, but still lagged developed country indices. Year-to-
policy. That led to technology stocks doing well, driving the date, emerging market equities have returned about 2%,
growth factor outperformance. underperforming developed markets by about 17% (see
Figure 10).
Figure 10. Differential between emerging and developed markets TR%
15%
10%
5%
Difference in total returns (%)
0%
-5%
-10%
-15%
-20%
-25%
Jan 21
Feb 21
Mar 21
Apr 21
May 21
Jun 21
Jul 21
Aug 21
Sep 21
Dec 19
Jan 20
Feb 20
Mar 20
Apr 20
May 20
Jun 20
Jul 20
Aug 20
Sep 20
Oct 20
Nov 20
Dec 20
23
All performance data is in US-dollar terms as of October 26, 2021. Source: Bloomberg.
© 2021 Mercer LLC. All rights reserved.Economic and market outlook 2022 19
Although we expect earnings to grow at a decent pace in There are also clear signals of market froth, with the
2022, the overall pricing of equity market beta is quite rich proliferation of “meme stock trading.” Higher bond yields
(even its valuation versus bonds has come down to the could also weigh on equity pricing in 2022, the same way
average level, see Figure 11). that they did in March 2021.
Figure 11. Equity valuations compared to bonds
8%
6%
4%
2%
0%
-2%
-4%
-6%
Jan 01
Jan 11
Jan 97
Jan 98
Jan 99
Jan 00
Jan 02
Jan 03
Jan 04
Jan 05
Jan 06
Jan 07
Jan 08
Jan 09
Jan 10
Jan 12
Jan 13
Jan 14
Jan 15
Jan 16
Jan 17
Jan 18
Jan 19
Jan 20
Jan 21
Long term equity earnings yield — US 10-year yield* Median
Source: Bloomberg as of October 26, 2021.
*When the line goes above the median, equities are cheap
compared to bonds, when the line drops below the media,
equities are relatively more expensive
Within equities, we find pockets of value, with certain (see Figure 12). We note the ever-increasing size of China in
regional segments trading at meaningfully lower earnings the emerging market equity complex, as China A-shares are
multiples, but for broad markets as a whole, we remain included in broad equity indices. The outlook for small-cap
neutral generally due to their rich valuations. Emerging equities is neutral, as a positive earnings outlook is balanced
markets stand out with very attractive valuations, which by relatively expensive valuations. We continue to advocate
informs our cautiously optimistic outlook on this sector an underweight to defensive equities.
© 2021 Mercer LLC. All rights reserved.Economic and market outlook 2022 20
Figure 12. Developed versus emerging market valuation, CAPE measure
14x
12x
10x
8x
Valuation multiples
6x
4x
2x
0x
-2x
-4x
-6x
Jan 11
Jan 21
Jan 03
Jan 04
Jan 05
Jan 06
Jan 07
Jan 08
Jan 09
Jan 10
Jan 12
Jan 13
Jan 14
Jan 15
Jan 16
Jan 17
Jan 18
Jan 19
Jan 20
DM-EM Median discount
Source: Bloomberg as of October 26, 2021.
© 2021 Mercer LLC. All rights reserved.Economic and market outlook 2022 21
Government bonds
Government bonds sold off sharply at the start of the year, September and October. Real bonds (inflation-linked bonds)
as the markets priced the reflationary environment. US rallied, generating positive returns overall in 2021.
government nominal bonds were off to the third-worst start
to a year since 1830,24 as breakevens (a measure of market- The selloff in nominal bonds was broad across developed
derived long-term inflation expectations) widened sharply market geographies, with the US and UK yields leading the
(see Figures 13 and 14). Real yields moved up higher, albeit way, followed by UK gilt yields moving up sharply higher,
more modestly. In the middle of the year, nominal bonds followed by the selloff in eurozone government bonds.
rallied due to Delta variant concerns and on the back of Japanese bonds have not moved much, with the central
supportive technical factors, before selling off once again in bank controlling the yield curve and inflation expectations
still anchored at very low levels.
Figure 13. Breakevens
5%
4%
3%
2%
1%
0%
-1%
Dec 13 Dec 14 Dec 15 Dec 16 Dec 17 Dec 18 Dec 19 Dec 20
US 10-year breakeven Japan 10-year breakeven Germany 10-year breakeven UK 10-year breakeven
Source: Bloomberg as of October 26, 2021.
24
Source: Jim Reid, Deutsche Bank.
© 2021 Mercer LLC. All rights reserved.Economic and market outlook 2022 22
Figure 14. Nominal yields
4%
3%
2%
Yields (%)
1%
0%
-1%
Dec 13 Dec 14 Dec 15 Dec 16 Dec 17 Dec 18 Dec 19 Dec 20
US 10-year Japan 10-year Germany 10-year UK 10-year
Source: Bloomberg as of October 26, 2021.
We believe bond yields will continue to move higher, of capital higher. In addition, central banks are turning
although the case for further expansion in breakevens is less accommodative by winding down their quantitative
weakening, especially in the UK, where bonds are already easing policies and talking about hiking rates, which should
pricing in higher inflation over the next decade and also weigh on government bonds. Do we think US 10-year
beyond. While it is unclear whether real yields will return government bond yields will move to 4% next year? No, but
to historically more normal levels, the risks appear on we think they will move modestly higher as the economy
the upside. Businesses are spending, governments are recovers, inflationary pressures persist and central banks
spending and climate change initiatives demand capital- become more hawkish.
intensive spending — all of these should drive the real cost
© 2021 Mercer LLC. All rights reserved.Economic and market outlook 2022 23
Credit
2021 was a fairly muted year in credit markets, with Going forward, we believe both investment-grade and sub-
investment-grade corporate bond spreads falling slightly investment-grade spreads offer little compression potential;
as the global economy recovered. Sub-investment grade however, they continue to offer some carry pickup.
(high yield) corporate bonds did somewhat better, although We believe defaults/downgrades will be low in this
spreads were much more stable than last year. Spreads environment, whereby “credit easing” is well within the
narrowed/widened in a pattern similar to equity market central bank toolkit, if it were ever to become necessary in
prices over the year (see Figure 15). subsequent crises.
Figure 15. Credit spreads
1,200
Options adjusted spread (basis points)
800
400
0
Dec 11
Apr 12
Apr 13
Aug 12
Dec 12
Aug 13
Dec 13
Apr 14
Apr 15
Aug 14
Dec 14
Apr 16
Aug 15
Dec 15
Aug 16
Dec 16
Apr 17
Aug 17
Dec 17
Apr 18
Apr 19
Aug 18
Dec 18
Apr 20
Aug 19
Dec 19
Aug 20
Dec 20
Apr 21
Aug 21
Barclays Global IG Spreads Barclays Global HY Spreads
Source: Bloomberg as of October 26, 2021.
© 2021 Mercer LLC. All rights reserved.Economic and market outlook 2022 24
Emerging market debt
Returns in emerging market local-currency bonds are driven of developed markets duration was negative, leading to
by two factors: the return bonds generate in their local overall negative returns.
currencies and the performance of those currencies against
developed market currencies. Although bonds have broadly We believe there is a case to be made for emerging market
held up in local-currency terms (see Figure 16), it was the local-currency bonds to do well because of cheap currencies.
depreciation in emerging market currencies that dragged However, significant risks remain, such as a more hawkish-
down the overall return profile. than-expected Fed that may lead to a stronger USD.
The outlook for hard-currency emerging market bonds
Returns in emerging market hard-currency bonds are also is positive from a spread-compression perspective, but
driven by two factors: the performance of US government negative from a developed-market-duration perspective.
bonds and whether the spreads of emerging market bonds On balance, we prefer local-currency bonds to
have widened or narrowed. 2021 saw emerging market hard-currency bonds.
spreads narrow (see Figure 17); however, the performance
Figure 16. Emerging market debt local currency
10% 8%
7%
9%
6.%
5%
8%
4%
Yield (%)
7% 3%
2%
6%
1%
0%
5%
-1%
4% -2.%
Apr 11
Apr 12
Apr 13
Dec 10
Dec 11
Apr 14
Apr 15
Dec 12
Apr 16
Apr 17
Apr 18
Apr 19
Dec 13
Dec 14
Apr 20
Dec 15
Dec 16
Dec 17
Dec 18
Apr 21
Aug 11
Dec 19
Aug 12
Dec 20
Aug 13
Aug 14
Aug 15
Aug 16
Aug 17
Aug 18
Aug 19
Aug 20
Aug 21
Yield Real yield (RHS)
Source: Bloomberg as of October 26, 2021.
8% 1000
7.5% 900
7% 800
6.5% 700
6% 600
Yield (%)
5.5% 500
5% 400
© 2021 Mercer LLC. All rights reserved.
4.5% 3006%
1%
Economic and market outlook 2022 25
0%
5%
-1%
4% -2.%
Apr 11
Apr 12
Apr 13
Dec 10
Dec 11
Apr 14
Apr 15
Dec 12
Apr 16
Apr 17
Apr 18
Apr 19
Dec 13
Dec 14
Apr 20
Dec 15
Dec 16
Dec 17
Dec 18
Apr 21
Aug 11
Dec 19
Aug 12
Dec 20
Aug 13
Aug 14
Aug 15
Aug 16
Aug 17
Aug 18
Aug 19
Aug 20
Aug 21
Yield Real yield (RHS)
Figure 17. Emerging market debt hard currency
8% 1000
7.5% 900
7% 800
6.5% 700
6% 600
Yield (%)
5.5% 500
5% 400
4.5% 300
4% 200
3.5% 100
3% 0
Aug 11
Aug 12
Aug 13
Aug 14
Aug 15
Aug 16
Aug 17
Aug 18
Aug 19
Aug 20
Aug 21
Dec 10
Dec 11
Dec 12
Dec 13
Dec 14
Dec 15
Dec 17
Apr 11
Apr 12
Apr 13
Apr 14
Apr 15
Apr 16
Dec 16
Apr 17
Apr 18
Dec 18
Dec 19
Dec 20
Apr 19
Apr 20
Apr 21
Spread (RHS) Yield
Source: Bloomberg as of October 26, 2021.
Currencies
At the time of writing, the US dollar continues to be well Debt section, emerging market currencies struggled,
supported against a basket of developed and emerging down by about 5%.
market currencies. It is up approximately 4% as measured
by the DXY index (see Figure 18). Strong US growth, We are modestly positive on the euro and the yen on
coupled with higher US bond yields, has underpinned the valuation grounds, with a slight preference for the euro.
performance of the global reserve currency. The euro has Although the US dollar has a few tailwinds behind it, we
lagged in 2021, down about 5% as the ECB retained its believe high US inflation, with the twin deficits (fiscal and
dovish stance and the eurozone economy lagged the US on trade) issues, should weigh on its performance. Emerging
a relative basis. One of the biggest movers of the year was market currencies are certainly cheap (see Figure 19) and
the Japanese yen, which depreciated by around 9% against may have plenty of room to recover; however, we believe
the US dollar, as the Bank of Japan retained its ultra-loose the time to buy should be after the Fed surprises the market
monetary stance and the economy struggled to gather with a hawkish announcement.
positive momentum. As noted in the Emerging Markets
© 2021 Mercer LLC. All rights reserved.Economic and market outlook 2022 26
Figure 18. US dollar index
105
103
101
99
97
Index
95
93
91
89
87
85
Jan 21
Feb 21
Mar 21
Apr 21
May 21
Jun 21
July 21
Aug 21
Sep 21
Dec 19
Jan 20
Feb 20
Mar 20
Apr 20
May 20
Jun 20
Jul 20
Aug 20
Sep 20
Oct 20
Nov 20
Dec 20
Figure 19. Emerging markets currency index
110 64
109 62
108 60
107
58
106
56
Index
Index
105
54
104
52
103
102 50
101 48
100 46
Jan 21
Feb 21
Mar 21
Apr 21
May 21
Jun 21
July 21
Aug 21
Sep 21
Dec 19
Jan 20
Feb 20
Mar 20
Apr 20
May 20
Jun 20
Jul 20
Aug 20
Sep 20
Oct 20
Nov 20
Dec 20
EM FX Real Effective (LHS) EM FX Spot (RHS)
Source: Bloomberg as of October 26, 2021.
© 2021 Mercer LLC. All rights reserved.Economic and market outlook 2022 27
Commoditities
Commodities have had one of their best years on record. and copper is up approximately 28% (see Figure 20). Soft
Disrupted supply chains, coupled with booming global commodities, such as agriculture, were broadly up. Precious
demand as economies reopened, have driven energy and metals, such as silver and gold, struggled as markets were
industrial metal prices sharply higher. At the time of writing, in a risk-on mode, weighing on demand for defensively
oil is up about 72% for the year, natural gas in the US rallied leaning assets.
by over 100%, while European gas rallied over fourfold
Figure 20. Commodity prices
300.00
250.00
200.00
150.00
Index
100.00
50.00
0.00
-50.00
-100.00
Jan 21
Feb 21
Mar 21
Apr 21
Jun 21
May 21
July 21
Aug 21
Sep 21
Jul 20
Dec 19
Jan 20
Feb 20
Mar 20
Apr 20
Jun 20
May 20
Aug 20
Sep 20
Oct 20
Nov 20
Dec 20
Crude oil US shale Natural gas Copper
70,000 4,500
60,000 4,000
3,500
50,000
3,000
Price
Price
40,000 2,500
30,000 2,000
1,500
20,000
1,000
10,000
500
0 0
Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep
19 20 20 20 20 20 20 20 20 20 20 20 20 21 21 21 21 21 21 21 21 21
Source: Bloomberg as of October 26, 2021
Bitcoin (LHS) Ethereum (RHS)
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