BlueBay Asset Management

“CURRENCY MARKETS MAY SEE LARGER MOVES THAN WITNESSED OF LATE, AS DIVERGENT MONETARY AND FISCAL POLICIES AND APPROACHES TO THE PANDEMIC LEAD TO MORE HETROGENUOUS AND DIVERGENT OUTCOMES.”

MARK DOWDING

CHIEF INVESTMENT OFFICER, BLUEBAY ASSET MANAGEMENT

2022 will witness a tightening of liquidity conditions as central banks, led by the US Federal Reserve, start to withdraw monetary accommodation launched since the start of the pandemic. This may represent something of a headwind for financial markets in the year ahead, making 2022 a time when beta returns are much more subdued than has been the case in the past several years. An assumed recovery from Covid should underpin robust economic growth and support corporate earnings. Perhaps the global inflation outlook will be one of the most influential and uncertain topics which will tax investors’ thinking. If an easing of supply bottlenecks sees price pressures cool, then this may contain the upward pressure on rates. However, if tight labour markets and shifting inflation expectations see inflation become more entrenched, there is a risk that markets will have been too complacent about a transition to a new macro regime.

From a political standpoint, the US Republican Party will surely score big gains at the midterms later next year, heralding a lame duck period for the remainder of Biden’s tenure. The French elections next spring could be the source of some market volatility but it remains unlikely that a more extreme candidate will prevail. Yet with Italian elections likely early in 2023 and with scope for a deepening rift between inflation hawks in the North, and growth and spending bulls in the South, Europe could look more divided at the end of 2022 than has been the case during 2021. Further east, China is set to remain in self-imposed Covid isolation. The Chinese property sector and construction more generally will remain pressured, yet the outlook for manufacturing and consumption should help limit downside risks to growth. Geopolitically, Russia/Ukraine represents an ongoing risk, but one the West can do little about. US/China relations seem unlikely to improve much and elsewhere the fallout from Covid may lead to idiosyncratic risks in some emerging markets resulting in divergent performance.

Declining policy support may also herald a period of higher volatility in the year ahead. Dispersion of returns between issuers and sectors may be a growing theme as markets focus on winners and losers after policy support starts to fade. Currency markets may also see larger moves than witnessed of late, as divergent monetary and fiscal policies, and approaches to the pandemic lead to more hetrogenuous and divergent outcomes. The past two years may not have been plain sailing for investors, though in equity markets most following a long only approach will have made good money. In 2022, we may witness a greater emphasis on hedge funds and absolute return strategies, as market beta starts to disappoint and as we pass the point of peak opportunity in private asset classes, such as private equity and private debt.