Geoffrey Smith

Investing.com — It’s been a grueling 2021. Many have experienced the pain of lockdowns, including bereavement and illness. The data on the economy show that there has been a strong rebound since the beginning of the pandemic. Trade and employment are growing at a rapid pace. These economic trends will continue, though at a slower rate in 2022. Progress has come at the expense of the arguably greatest inflation threat since 1970s. It will be difficult to manage that threat and avoid a market crash that still trades at historic high multiples. These are the top trends you should be watching as we move into 2022.

1. Global Monetary Tightening Cycle

Inflation will rule the year ahead. In truth, rising interest rates already arrived in style in 2021 in many parts of the world, but the Federal Reserve, guardian of the world’s reserve currency, has now made the process truly global. 

As the Fed ends its quantitative easing program, which is currently running at $120 million per month, the longer-term rates will rise first. It’s expected to raise the target range for Fed funds by as much as 75 basis points between March and the end of the year.

It will be determined by the inflation path during this period whether or not it tightens. Base effects and – more importantly – a likely slowdown in the economy as the excess savings of 2020 are finally spent, suggest that inflation should weaken in the course of the year: the Fed itself sees core personal consumer expenditures rising only 2.6% next year, after a 5.3% increase this year. A major factor in the Fed’s ability to withstand Congress’ increasing pressure as mid-term elections draw near in November will also be important.

Either way, as long as the Fed remains in tightening mode, the pressure on other central banks – with the exceptions of Switzerland, Japan, and possibly China – to keep tightening will remain.

2. Three years of covid…

It is likely that the course of the pandemic has the largest impact on the Fed’s thinking and the other central banks. As of the time of writing, the Omicron variant is on a tear through Europe and is now present in 43 of the U.S.’s 50 states.

Omicron’s biology is still not clear enough for us to predict with certainty. It is more likely than the Delta-dominant strain to cause serious illnesses, and it can also escape the immunity generated by two shots vaccinations, which allows it to spread quicker. 

A lower virulence level will not suffice to keep you from being locked down again if there is a steady increase in the number of infections every day, which it does across the globe.

Encouragementally, it appears that booster shots of The Moderna Pfizer/BioNTech vaccins and (NASDAQ:) will give Omicron time to develop new medicines. Equally, the supply of vaccines and, increasingly, antiviral drugs continue to expand, especially through the WHO’s Covax program.

That should reduce the disparity in access to vaccines that has given the virus freedom to thrive and mutate at will in the world’s poorer countries. COVAX’s current forecast predicts that it will make 2.39 billion doses of vaccine available in March. There are also options to produce more than 6.5 billion doses before 2023.

3. China’s Trifecta: Omicron, Evergrande and Taiwan

Omicron may seem less dangerous to human life than all dominant Covid-19 strains before it, but it still poses a serious threat to financial markets because of the reaction function of the world’s two largest economies.

The risk of transmission to children in the United States is particularly high due to vaccine hesitancy. This could cause high levels of absenteeism and worsen existing labor shortages. China’s tendency to respond to Covid with hardening and broad locking down is what poses the greatest supply-side threat. Due to the low effectiveness of Omicron vaccines in China, there is a risk of new closures at key logistics and manufacturing hubs throughout the year. This would further complicate the problem for other retailers and manufacturers.

China faces many other challenges next year. At some stage, the country’s authorities will have to decide who gets to bear the losses on debts owed by China Evergrande Group and other over-extended real estate developers. The country’s authorities will need to decide without creating panic among investors and without resorting yet to more borrowing in order to recover from a slowdown in growth. 

Any sign of financial or even social instability may embolden Beijing to distract attention with a little foreign policy adventure: after ending Hong Kong’s autonomy, President Xi Jinping, with what amounts to a fresh mandate from the Communist Party to rule for life, has made no secret of his desire to restore mainland sovereignty over Taiwan.

4. Europe’s Energy Crisis

Geopolitical risk is also one element – but only one element – of another story set to dominate headlines in Europe, especially early on in 2022. With Russian President Vladimir Putin’s threat of an invasion, the old year is over. He argued that NATO’s expansion to eastward is a existential threat.

Analysts tend to believe that Russia’s military actions at Ukraine’s border are a way to pressure Gazprom to open the Nord Stream 2 pipeline. This controversial project promises to bring in a lot of money for Gazprom and its state-owners. It is not possible to take Putin’s “military-technical” action as a fact. He made this explicit in a speech to the defense chiefs on Tuesday, just before Christmas.

The fact that Europe is unable to respond to an invading force as in 2008 (when oil was still at $100/barrel) would hinder its ability. Its prices for power and natural gas are far higher than ever before. These include a lack of stored gas and increasing restrictions on coal power.

It is now painfully clear that the consequences of wanting an Energy Transition to be realized without having supplies secured are very real.

Already, the rising cost of energy for household bills will add 1% to U.K. inflation by April. This is because a price cap has been lifted. It is also forcing Spain and Italy to increase subsidies that were previously included in energy bills to help with an immediate crisis. Fertilizer makers and other gas-intensive industries have had to shut down factories already. The risk of more being forced to do so as utilities cut back on supplies.

5. Can OPEC and USA keep up with oil demand?

Omicron’s spread has put an end to all speculation about when global oil demand will reach its peak pre-pandemic. However, it appears certain that it will do so soon, prompting questions from both OPEC policy and U.S. policies.

American Petroleum Institute data showed that U.S. consumption was only 0.4% below its peak level by November. The latest outbreak of illness put an end to air travel but also road travel. When demand does finally recover, it’s not clear that supply will be able to keep pace: economic uncertainty and increasing environmental activism by shareholders and governments have led to falling investment in new production. Rystad Energy’s analysis suggests that discovery will fall to its lowest point since 1946 by 2021, barring any miracle in the final days of the year.

“Those who believe most recent price inflation is temporary may misunderstand the time required for oil and gas investments,” Dean Foreman, the API’s chief economist, warned in a recent note. Both OPEC producers and U.S. oil companies were more focused on repairing their balance sheets rather than increasing the supply in this year’s OPEC. To avoid another rise in oil prices by 2022, it will probably take both sides to change their minds.

6. Crypto’s Watershed Year

The global tightening cycle in monetary policy will be a tough test for cryptocurrency, which has shown a growing correlation with speculative investments over the last year. After all, speculative assets are more likely to suffer from rising interest rates.

But, those committed to crypto will find 2022 to be an interesting year. In which India, Europe, and the U.S. all expect to clarify the regulatory direction on travel, this should give the asset class a firmer legal foundation.

On a technical level, the event of the year may be the completion of Ethereum’s transition to the Proof-of-Stake mechanism on its blockchain, moving away from the more energy-intensive Proof-of-Work mechanism that constrains scalability (as well as generating heaps of bad press for crypto on environmental grounds). Given Ethereum’s place in the universe of decentralized finance (DeFi) initiatives now multiplying, the importance of the transition can hardly be overstated.

Elsewhere, the progress of Polygon, which provides an infrastructure for different blockchains to communicate with one another, may also expand the ease of use of many coins – although it will make it harder for enthusiasts to argue that the more than 6,000 digital coins now in existence derive their value from their scarcity.