Interest rates will subside in 2022

Prior to the pandemic, concern about inflation seemed outmoded.

But as the world economy recovered from covid-19’s terrible recession, the same problem resurfaced.

Inflation climbed to 5% in the US and 3% in the UK, and much more in many emerging nations.

Some experts predicted a recurrence of the 1970s’ high inflation.

Things will get better in 2022, but not before making central bankers nervous.

Inflation rates began to fall in the 1980s and continued to fall until 2020.

The decline reflected central bankers’ achievement in controlling inflation, but it was also helped by structural developments. Wage growth slowed as globalization cut production costs and worker negotiating strength. And as the wealthy aged, they saved more, thus spending grew less in response to rising income.

Following the global financial crisis, inflation consistently undershot central banks’ inflation targets, prompting some, like the US Federal Reserve, to relax their inflation targets.

Then covid-19. Central banks pumped massive sums of money into the banking system to bolster it. Governments borrowed on a scale not seen since WWII to help individuals unable to work.

In 2020 and 2021, the US federal budget deficit exceeded 12% of GDP.

This boost kept demand from falling, but supply did. Covid-19 halted manufacturing of goods and services. Droughts and heatwaves hampered coffee and wheat yields. Global shipping issues caused enormous freight backlogs. Insufficient fuel supplies prompted prices of coal, gas, and oil to skyrocket as winter neared, recalling the 1970s energy shocks.

Firms’ inability to fill vacancies may signal the end of weak labor power.

A Central banks may be overconfident about inflation concerns since they increasingly prioritize low unemployment. Inflation can self-feed.

People may become accustomed to higher and more frequent price increases, making price hikes less harmful to company. Prices may become “unanchored,” as economists argue. Increasing energy costs could stifle growth.

Workers are in high demand. The lack of labor is currently the most critical concern facing the economy.

Lack of supply and manpower is a hindrance.

The COVID-19 pandemic disturbed many workers’ lives, but not their salaries. Online demand soared as worldwide manufacturing was hindered.

At the same time, China is striving to reduce financial system leverage, particularly in the housing market. The market undervalues China’s deliberate and persistent business model change. China is no longer simply focused on leveraging real estate to become a middle-income country. It can’t let go of a problem, therefore China is revising its growth paradigm.

China’s economy has been fueled by real estate. Before the global financial crisis, it was around 10%-15% in the US. So a concerted slowdown in China, but nothing frightening in terms of a hard landing. But it comes at a time when the US and European economies are hampered by a lack of products and services.

So, how does it go? Both the US and China’s growth rates are dropping.

We have supply and labor shortages because incomes have risen, federal policy assistance has surpassed that of WWII, and now the economy is recovering. We underestimated supply chain difficulties, yet demand continues to grow. Hence increased inflation, but not stagflation.

Demand is under tremendous pressure and will continue to be. One factor for the rapid deterioration of conditions is that many workers have given up looking for work. This will help ease some of the stress. Given the global economy’s recent shocks, rising wages will attract workers, which is welcome news. But this changes the forecasting risks. The risk in the next six months is slower growth in the US and a slowdown in China due to its real estate crackdown.

If the markets are vulnerable to a short-term decline in growth, the longer-term risk comes when supply chain disruptions start to ease. When all those cargo containers off the Los Angeles port are ultimately unloaded, the Federal Reserve will need to normalize policy.

Interest Rates in 2022 & Beyond –

To combat all of this inflation, the Fed said in December that it would double its balance sheet reduction rate. 

But this is happening at the height of inflation. 

The yield curve is already sloping in the direction of inversion, even before the tapering of quantitative easing begins. 

There is now only a 75 basis point gap between the 2-year and the 10-year. 
There will be minimal room to raise rates before an inversion happens once the QE taper is completed. 

US hikes for March, June, and December are now priced. An additional 47% hike in November and 40% hike in February are planned. 

The market predicts 4 rate hikes in the next 14 months. 

While inflation will continue to exceed central bank targets in 2022, it will slow from 2021 and eventually fade away.

Prices should fall in the spring due to less demand, greater fuel output, and possibly a slower Chinese economy.

Shipping issues may take longer to resolve. But global stimulus is dwindling, and rising energy costs are squeezing household finances. As vaccination rates grow, more people may return to the workforce, reducing shortages of goods.

Most importantly, many of the structural factors that slowed inflation prior to the epidemic still exist.

Despite the strains on global supply systems, there are few signs of a broad reversal in globalization.

No one has forgotten how to control inflation. In fact, global interest rates will subside in 2022.