The year ahead in 2022
Scanning ahead a year is a fools game. But there are known unknowns with knowing.
Fundamental uncertainty makes scanning the year ahead a fraught exercise, apt to be soon forgotten;
Still, there are events known today that will shape the year ahead. Before returning to our usual money-macro themes next week, we start the year by noting some of the key known-unknowns in 2022;
In particular, these themes include: Russia’s NATO ultimatum; the new Bundesbank President; the revision of fiscal rules in the EU; Draghi’s fate; the global election cycle; and, of course, the evolution of monetary policy.
In motivating the idea of fundamental uncertainty in 1937, Maynard Keynes explained the difference between future events that can be assigned a probability—risk—and that which cannot:
By “uncertain” knowledge, let me explain, I do not mean merely to distinguish what is known for certain from what is only probable. The game of roulette is not subject, in this sense, to uncertainty; nor is the prospect of a Victory bond being drawn. Or, again, the expectation of life is only slightly uncertain. Even the weather is only moderately uncertain. The sense in which I am using the term is that in which the prospect of a European war is uncertain, or the price of copper and the rate of interest twenty years hence, or the obsolescence of a new invention, or the position of private wealth-owners in the social system in 1970. About these matters there is no scientific basis on which to form any calculable probability whatever. We simply do not know.
Engaging in year-ahead stargazing given such fundamental uncertainty is, therefore, folly. The pandemic was not on the market radar only 2 years ago; the acceleration of inflation last year in the US was largely unseen. As such, many of the key themes that will shape market pricing over the year-ahead are as yet unknown.
Still, there are key events that will shape the contours of the year ahead that we know about already, even if we don’t know the precise outcomes. Navigating these events is the best we can do as the year begins. So before returning next week to the usual money-macro themes that will occupy us throughout the year ahead, we note here some of the events we are watching in 2022.
Russia: Pressing Its Sphere of Influence
The year started with Russian forces amassed at the border between Russia, Ukraine and Belarus. The Russian Westward military deployment, accompanied by an aspirational list of strategic demands for a Russian sphere of influence, raises the prospect of the year beginning with deteriorating relations between NATO and Russia—and the possibility of open warfare between Russia and Ukraine.
There is much discussion of what is really motivating this belligerence, and how far the US and NATO will go to meet Putin’s demands. What is clear is that there is a material risk of open-warfare in Eastern Europe.
As well as being a crisis for NATO, the consequences will be most felt by the people of Ukraine, of course. But for the global macro story, the impact on gas flow to Western Europe during this and future winters, and further impact on energy prices, will be the most immediate. Comments this weekend by ECB Board Member Schnabel on the monetary policy reaction to energy prices are therefore given more importance.
New Bundesbank leadership
This year marks the one-hundredth anniversary of the Weimar inflation—the cost of living increased 17 fold in the second half of 1922, further accelerating into 1923 as reparations payments went off track and French occupation of the Ruhr led to widening fiscal deficits.
While no longer a living memory, the fear of inflation in Germany lives on. And this at a time when inflation in Germany and the Eurozone will break post-euro inflation records.
This forms a tricky backdrop for incoming Bundesbank President Joachim Nagel. There will be a formal handover ceremony from Jens Weidmann on Tuesday next week. Since Nagel’s views on monetary policy are largely unknown, his comments will be closely watched. A likely hawk, it will interesting witness his views on the ECB policy stance as the year progresses—and whether he chooses to be confrontational or constructive.
EU fiscal rules
Post-pandemic revision of the EU fiscal rules—the Stability and Growth Pact (SGP)—is likely in the first half of this year, an opportunity to wind back the deflationary bias built into their current formulation. This will matter for the EU business cycle over the next decade.
There have been numerous contributions to this discussion already. To mention but three:
The European Stability Mechanism (ESM) published a staff-level paper suggesting the debt-to-GDP target could be increased to 100% of GDP while keeping the 3% deficit target.
The ECB, representing the Eurosystem, offered their views to the Commission with some sensible though vague suggestions to clean up the SGP: fiscal policy should be sustainable but supportive; simpler and predictable, with realistic and gradual downward adjustment of debt stocks; a central fiscal capacity would be helpful—eventually.
Economist Olivier Blanchard, formerly of the IMF and MIT and currently of the PIIE, has published the pre-print his book on Fiscal Policy Under Low Interest Rates intended to nudge the debate forward. He advocates fiscal standards instead of rules—loose prescriptions rather than numerical targets—and stochastic debt sustainability assessments.
Ultimately, however, this is a political decision. And it will be taken during the French Presidency of the EU in H1. It may be important that Italian Prime Minister Draghi can play unique role in this negotiation as former ECB President—if he is around the table, see below.
Indeed, last month, in an attempt to set the agenda for the debate, President Macron of France alongside Draghi wrote an op-ed in the Financial Times calling for a renewed framework that would not only bring down national levels of indebtedness but increase fiscal space for “investments which undeniably benefit the welfare of future generations and long-term growth.”
The proposed emphasis on facilitating investments that allow for sound (i.e. “green” and “digital”) inter-generational growth conveniently dovetails with the key priorities of the newly minted German Traffic Light Coalition, which itself has reserved a key role for green and sustainable investments.
So there is scope for a progressive agreement—though changing the SGP is very complicated.
The usual debt hawks are already circling to re-impose budget discipline, not least during a period of accelerating inflation. Though it is positive to note that the incoming Dutch Finance Minister, Sigrid Kaag (not an economist by training), is pro-European, opening the door further to some flexibility on “green” fiscal programs.
A likely compromise will be to carve out some space for green investments that will not be included in the debt or deficit calculations—say, 1% of GDP per year—while continuing with the (perhaps artificial) understanding that debt targets are a sensible hook for medium-term fiscal policy.
Italian and French politics
The prospects for SGP revision, and much more, will be impacted by political movements early in the year, of course.
In Italy, there is the prospect of further political instability if PM Draghi moves (or is moved) to replace outgoing President Mattarella. A joint session of the Italian Parliament on January 24 will begin the process of picking the new President.
In France, the pressure of having to run a fiercely contested Presidential Election will weigh on Emanuel Macron in April 2022.
In both countries, the pro-European center is expected to prevail. But right wing candidates are viable and at times command majorities in the polls in both France and Italy.
Central and Eastern Europe
Parliamentary elections are also scheduled in Hungary for the Spring of 2022. The incumbent, Prime Minster Orban, is being challenged by a united coalition of opposition parties led by Marki-Zay. Recent polling suggests that the united opposition is neck-in-neck with Orban’s Fidesz-KDNP coalition, a race the opposition could well win. The candidate for the United Opposition is likely to more attuned to working constructively with other EU members.
In Poland, also out-of-favour in Brussels, the reigning coalition is tethering and early elections are possible. Similar to Hungary, the incumbent coalition is confronted with intractable economic challenges which triggered virulent “national values” policies that conflict with EU values.
Both countries are therefore embroiled in Rule of Law conflicts with the EU as reflected in a stoic opposition by the European Parliament to releasing promised Next Generation (NGEU) funds agreed during the pandemic. The European Court of Justice is furthermore expected to rule on (and to dismiss) Hungary/Poland’s challenge to the Rule of Law Regulation in Q1 (likely mid-Feb.)
And the resources available are substantial—6.8% of loans and grants for Poland and 5.3% of grants for Hungary through 2026. It is unlikely these funds will be overlooked for long, whose prospect could also help realign domestic politics with EU values.
Brazil, the US, and China
Briefly gazing beyond Europe, three other major elections will take place later in 2022:
In October, Brazilian President Bolsonaro will be challenged by former-President Lula da Silva in a re-run of the unsettling Right v. Left discussion that continues to roil Brazil;
In November, the United States will hold mid-term elections for Congress, where political control of the House of Representatives and/or the Senate might shift to Republicans, potentially depriving the Pres. Biden’s Democratic Party of the vaunted reconciliation path to enacting fiscal legislation;
While also in November, the likely election of Chinese President Xi Jinping to a third term will see continuity in overseeing the rocky relationship with the United States—following the another Olympic Games under global pandemic conditions.
An interesting outstanding question is whether the year ahead will come to be dominated by monetary policy, as was the case in 2021. What is certain, the inflation debate will continue for some time yet.
What does appear likely, if inflation allows, is that balance sheet shrinkage by both the Fed and the Bank of England will begin. This is interesting as it is relatively untested, and the precise understanding of how this work and how this should be managed is evolving.
We will be watching central bank balance sheets very closely in the year ahead and reporting here.
The content in this piece is partly based on proprietary analysis that Exante Data does for institutional clients as part of its full macro strategy and flow analytics services. The content offered here differs significantly from Exante Data’s full service and is less technical as it aims to provide a more medium-term policy relevant perspective.
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