What could go wrong? The biggest economic risks for 2022

The COVID years are full of projections that didn’t work out. For those of you watching 2022, that should be enough to ponder.

Most of the analyzes, including that of Bloomberg Economics, have as a baseline scenario a solid recovery with a cooling in prices and a move away from emergency monetary policy configurations. What could go wrong? Many things.

What are some items on the risk list? Let’s see: omicron, persistent inflation, the takeoff of the Fed, Evergrande, Taiwan, a run on emerging markets, a hard Brexit and a new euro crisis, among others.

Now, certain things can also turn out better than expected, of course. Governments can decide to keep fiscal support in place; China’s latest five-year plan could catalyze stronger investments; money saved during the pandemic could drive spending globally.

These are the global economic risks for 2022:

Omicron and more closures

It is too early for a final verdict on the omicron variant of COVID-19. Although apparently more contagious than previous variants, it can also be less deadly. That would help the world return to something like pre-pandemic normalcy, which means spending more money on services. Closures and COVID caution have driven people away from gyms or restaurants, for example, and encouraged them to buy more stuff. A rebalancing of spending could boost global growth to 5.1% from Bloomberg Economics’ base forecast of 4.7%.

But we may not be so lucky. A more contagious and deadly variant would drag economies down. Even a three-month return to the toughest restrictions of 2021 (countries like the UK are already moving in that direction) could slow growth from 2022 to 4.2%.

In that scenario, demand would be weaker and global supply problems would likely persist, with workers out of labor markets and more logistical problems. Already this month, the Chinese city of Ningbo, home to one of the world’s busiest ports, suffered further closures.

Threat of inflation

At the beginning of 2021, the United States was forecast to close the year with inflation of 2%. Instead, it is close to 7%. In 2022, once again, the consensus predicts that inflation will end next year near the target levels. Another important difference is possible.

Omicron is just a potential cause. Wages, which are already rising rapidly in the United States, could rise further. The tension between Russia and Ukraine could cause a rise in gas prices. As climate change brings more disruptive weather events, food prices may continue to rise.

Not all risks go in the same direction. A new wave of the virus could affect travel, for example, dragging down oil prices. Even so, the combined shock could still be a stagflationary shock that leaves the Fed and other central banks with no easy answers.

Fed and rate hike

Recent history, from the tapering in 2013 to the stock sell-off in 2018, shows how a tight Fed spells trouble for the markets.

This time, in addition to the risks, there are already high asset prices. The S&P 500 Index is close to bubble territory, and accelerating home prices suggest that housing market risks are greater than at any time since the subprime crisis of 2007.

Bloomberg Economics modeled what happens if the Fed makes three hikes in 2022 and signals that it will continue until rates hit 2.5%, raising Treasury yields and widening credit spreads. The result would be a recession in early 2023.

Takeoff of the Fed and emerging markets

The Fed take off could spell a hard landing for emerging markets. Higher rates in the United States generally boost the dollar and cause capital outflows – and sometimes currency crises – in developing economies.

Some are more vulnerable than others. In 2013 and 2018, the ones that suffered the most were Argentina, South Africa and Turkey. If we add Brazil and Egypt, that would be the list of the five economies at risk in 2022, according to a series of measures compiled by Bloomberg Economics.

Saudi Arabia, Russia and Taiwan – with little debt and strong current account balances – seem less exposed to capital flight in the emerging world.

China could crash into a great wall

In the third quarter of 2021, China’s economy came to a standstill. The cumulative weight of Evergrande’s decline, repeated COVID lockdowns and energy shortages reduced annual economic growth to 0.8%, well below the 6% pace the world has become accustomed to.

While the energy crisis should subside in 2022, the other two problems may not. Beijing’s zero COVID strategy could mean lockdowns to contain the spread of omicron. And with weak demand and limited funding, property construction, which powers about 25% of China’s economy, could continue to decline.

The Bloomberg Economics baseline scenario is that China will grow 5.7% in 2022. A slowdown to 3% would create ripples around the world, leaving commodity exporters without buyers and possibly undermining the Fed’s plans.

Political turmoil in Europe

Solidarity between leaders backing the European project and European Central Bank activism to keep government borrowing costs under control helped Europe weather the COVID crisis. In the next year, both could disappear.

The fight for the Italian presidency in January could topple the fragile coalition in Rome. France heads to the polls in April, for which President Emmanuel Macron faces challenges from the right. If Eurosceptics gain power in the bloc’s key economies, it could break the calm in European bond markets and deprive the ECB of the political support needed to respond.

Feeling the impact of Brexit

Negotiations between the UK and the EU on the Northern Ireland Protocol – a doomed attempt to square the circle of an open land border and a closed customs union – could make noise in 2022. Getting there will be difficult.

What happens if the negotiations fail? According to pre-Brexit crises, the uncertainty would affect business investment and undermine the pound, driving inflation and eroding real income.

The future of fiscal policy

Governments spent a lot to support workers and businesses during the pandemic. Many now want to tighten their belts. The decline in public spending in 2022 will amount to 2.5% of world GDP, about five times higher than the austerity measures that slowed recoveries after the 2008 crisis, according to UBS estimates.

There are exceptions. Japan’s new government announced another record stimulus and Chinese authorities signaled a shift toward supporting the economy after a long period of budget control.

In the United States, fiscal policy went from boosting the economy to slowing it down in the second quarter of 2021, according to the Brookings Institution. That will continue into next year, although President Joe Biden’s plans to invest in clean energy and childcare will limit resistance if they win congressional approval.

Food prices and discomfort

Hunger is a historical driver of social unrest. A combination of the effects of COVID and bad weather pushed world food prices near record highs and could keep them high next year.

The last food price shock in 2011 triggered a wave of popular protests, especially in the Middle East. Many countries in the region remain exposed.

Sudan, Yemen and Lebanon, already under pressure, seem at least as vulnerable today as they were in 2011, and some are more so. Egypt is only slightly better.

Popular uprisings are seldom localized events. The risk of further regional instability is real.

political, geographical or local

Any escalation between mainland China and Taiwan, from blockade to invasion, could attract other world powers, including the United States.

A superpower war is the worst case scenario, but other than this include sanctions that would freeze ties between the world’s two largest economies, and a collapse in Taiwan’s production of semiconductors that are critical to global production of everything from smart phones to cars.

Brazil will hold elections in October, in a context of turbulence caused by the pandemic and a depressed economy. Many things could go wrong, although a victory for a candidate who promises greater control of public spending could be a relief to the real.

In Turkey, the opposition is pushing to advance the 2023 elections to next year amid a currency slide that is widely attributed to the unorthodox economic policies of President Recep Tayyip Erdogan.

And now what could go well in 2022?

Not all risks are negative. Budget policy in the United States, for example, could remain more expansionary than seems likely at the moment, keeping the economy off the edge of the fiscal cliff and fueling growth.

Globally, families have trillions of dollars in excess savings, thanks to the stimulus of the pandemic and the frugality imposed during the shutdown. If it is spent faster than expected, growth will accelerate.

In China, investments in green energy and affordable housing, already scheduled in the country’s fourteenth five-year plan, could increase investment. Asia’s new trade agreement, the Regional Comprehensive Economic Association – which encompasses 2.3 billion people and 30% of world GDP – could boost exports.