Key Macro Assumptions For 2022

Market returns in 2021 were excellent amid a rocky economic backdrop for the second half of the year. Concerns about the Omicron variant, persistent inflation, and potential rate hikes by the Federal Reserve will follow the market into 2022. With no more fiscal stimulus expected, and the effects from past rounds waning over time, the stage for investors is getting set for a perfect storm.

Everyone has their own risk appetite and investing goals, but I would factor in two core assumptions to any plan going forward.

1) Inflation driven by supply-chain constraints and a tight labor market will remain an issue in 2022

2) The Federal Reserve will raise rates in 2022 and accelerate their bond tapering

These two assumptions go hand in hand, as the federal reserve will want to tighten their monetary policy in reaction to continued inflationary pressures. As of now, it is more likely than not, in my view, that the inflation felt in the latter half of 2021 will not go away. Bottlenecks in the global supply chain still haven’t been resolved, and the labor market remains stubbornly tight; the turn of the year hasn’t magically fixed these issues. Disruption from Omicron, or possibly another new variant down the line, is also in the cards this year.

We know that the Federal Reserve believes in this too, as evidenced by them no longer referring to the current inflationary wave as “transitory.” A majority (12/18) of the Federal Reserve’s Open Market Committee sees at least three rate hikes in 2022; five out of the six who don’t expect at least two hikes.

Where inflation, and what the Federal Reserve will do, is impossible to predict with certainty. What we do know right now is that inflation is raging and that the Federal Reserve is signaling the markets that they are prepared to fight it with higher rates.

Inflation and rate hikes will dampen equity returns for 2022. Higher inflation means higher input costs for businesses, and the ones unable to pass on these costs to customers will have to absorb them, resulting in a bottom-line hit. The decline in the dollar’s value also means that returns have to be higher to compensate for the erosion of purchasing power. Rate hikes, which makes credit lines more expensive for consumers and products, will slow the economy down too. And with past fiscal stimulus waning and nothing more on the horizon, investors should temper their 2022 return expectations.

Even if the inflation doves are proven correct, and inflation dramatically cools down in 2022, it would still be prudent to hedge your portfolio against inflationary pressure and the interest rate hikes which come with it. Not doing so could you leave exposed to significant downside if inflation continues to rage and there are more rate hikes than anticipated; it’s better to prepare for the worst than be caught off guard.

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