Economic Outlook
Global recovery hampered by headwinds
The global economy, which rebounded strongly from pandemic-induced woes in the first half of 2020, has run into several roadblocks. While broad-based growth will continue, it will be slowed by persistent supply chain bottlenecks that have been exacerbated in part by China’s zero-COVID approach, as well as the onset of the Russia-Ukraine conflict in February this year.
Policy support key to sustained growth
This combination of factors has led to spiralling increases in energy and food prices. It has also prompted major central banks, including the US Federal Reserve (Fed), to tighten monetary policy and raise interest rates in efforts to quell inflation concerns. Much of the growth trajectory ahead will depend on when inflation peaks and subsides, and the policy support implemented by the leading economies and governments to tackle these global challenges.
Fallout from Russia-Ukraine conflict and China’s COVID-19 policy
As most countries shift into post-pandemic reopening mode, new pressing issues have emerged. These include the threat of global inflation from chokepoints in global supply chains, due to China’s zero-COVID policies and disruptions in energy1 and food supplies2 because of the Russia-Ukraine conflict.
The two countries account for about 29% of the world’s wheat supply. This disruption, combined with international sanctions on Russian oil and gas exports, have led to rising commodity prices and heightened awareness of the need for resilient supply chains and food security. These have prompted countries that rely heavily on Russian energy to seek alternative sources of fossil fuels, as well as renewable sources, such as solar and wind power.
US growth slower but still expanding
With higher transport, energy and food costs pushing global inflation levels to multi-year highs, global central banks led by the US Federal Reserve (Fed) have raised interest rates in efforts to combat inflation. The Fed has hiked its key interest rates by 50 basis points (bps) in May and 75 bps in June this year.
While the US reported a surprise 1.4% contraction (annualised rate) in Q1 2022 GDP3, the American economy is still in an expansionary phase, underpinned by strong jobs and wage growth. US household assets remain high and can support a rise in private consumption (Figure M1). There are also sufficient buffers from significant household savings (Figure M2) and a pipeline of new investments in the energy sector.
Lockdowns threaten China’s growth target
The Chinese economy grew 4.8% on an annualised basis in Q1 2022, on the back of a strong rebound during the first two months of the year. The state’s zero-COVID policies, including strict lockdowns and mobility curbs, have since put growth at risk. Whether the government will be able to meet its 2022 growth target of 5.5%4 will hinge on how the Omicron variant’s spread will be brought under control, as well as the extent of its economic policy support. There is a possibility that the government may relax its zero-COVID stance towards Q4 2022 if the pace of growth stalls.
Figure M1. US household assets remain high and can support a rise in consumption.
Source: Macrobond, UOB Private Bank.
Figure M2. US savings rate has fallen below its long-term trend, showing increased spending.
Source: Macrobond, UOB Private Bank.
Interest Rates and Bond Yields
US inflation is likely to stay high into Q3 2022 following the unexpected Russia-Ukraine conflict and its impact on energy and food prices.
The Fed is likely to continue raising interest rates (Figure M3). We expect the Fed to hike by 0.50% in July, September and November before ending the year with a 0.25% hike in December.
We expect the benchmark 10-year US Treasury (UST) yield to cross and remain above 3.9% by Q1 2023. For H2 2022, we expect policy interest rates to trend upwards, lifting the shorter end of the yield curve5. Quantitative tightening measures by the Fed will boost longer-term yields.
Uneven shifts in short- and long-term bond yields may lead to occasional yield curve inversions5 in H2 2022. This is a recession indicator that requires close monitoring, but we currently do not expect a US recession to occur in the next six to 12 months. Our forecast is that the US economy will expand by 2.0% in 2022.
Hence, selection will be key within the fixed income space due to expected rising yields. Our preference is for short-duration bonds that are more defensive and a basket of high-quality bonds that offer better portfolio resilience and margin of safety together with diversified income streams.
Figure M3. The Fed is expected to hike interest rates at every meeting for the remainder of 2022 to curb inflation.
Source: UOB Global Economics and Markets Research (June 2022).
Currencies and Commodities
The US dollar (USD) is expected to strengthen further as the Fed hikes interest rates and shifts to quantitative tightening (QT) measures which raise borrowing costs. The euro (EUR) and Chinese yuan (CNY) will weaken against the USD amid concerns over slowing growth. The Australian dollar (AUD) may firm up on the back of higher commodity prices.
Stay positive on gold, which is expected to reach US$2,000/oz by end-2022 due to its safe-haven status amid commodity-driven inflation fears and geopolitical tensions, but near term upside is limited by a strong USD. Brent crude oil is expected to rise to US$130/bbl towards end-2022 amidst ongoing supply disruption and falling inventories.
Corporate Earnings and Equities
Overall, corporate earnings will remain positive (Figure M4) but grow at a more modest pace, as the momentum in global economic recovery slows after rebounding sharply in 2021.
US companies are expected to see steady earnings growth from underlying economic strength and a recovering labour market. European companies face challenges in consumption due to high inflation, but will still be able to pass on most cost increases to customers. Meanwhile, large energy companies on the continent will see higher profits in 2022 due to soaring oil prices.
Over in Asia, Chinese companies will likely face headwinds due to zero-COVID policies but like their Asia ex-Japan peers, will still maintain their earnings growth.
Equity valuations, as measured by forward price-earnings (PE) ratio (Figure M5), are attractive in Europe, Japan, and Asia ex-Japan versus the US. Investors with a longer time horizon can consider building positions gradually at current valuations. Asian equities will likely get a boost from post-pandemic reopening. We remain cautious towards European equities in the near term due to the conflict in Ukraine.
Investors ought to stay prudent by maintaining an equities portfolio diversified across geographic regions, and investing in value sectors such as Financials which will benefit from the rising interest rate environment. Cheap valuations and dips from sell-offs may offer buying opportunities.
Figure M4. Earnings remain strong, even as sentiments are less optimistic and more cautious in the near-term.
Source: Bloomberg (31 May 2022).
Figure M5. European and Asian corporate earnings are expected to remain positive, with cheaper valuations than the US’.
Source: Bloomberg (31 May 2022).
Key Drivers and Risks for H2 2022
Summary of Asset Class Views
Markets are expected to remain volatile for the rest of 2022. We are selective within equities and fixed income due to rising interest rates led by the Fed and slowing global growth.
Align your portfolio according to your risk appetite using our Risk-First approach to avoid taking on more risk than you are comfortable with. In addition, consider holding some cash for future market opportunities. Opportunistic investors can consider investing in our selected high-conviction calls for Tactical investing.
3 Key Takeaways for 2022
Other useful information that you may like to know:
- 1Accelerating the end of Europe’s Russian gas habit, Financial Times 30 April 2022.
- 2World food prices hit new record on impact from Ukraine war, 8 April 2022.
- 3UOB Macro Note – US GDP: A Surprise 1.4% Contraction In 1Q Does Not Point To Recession, 29 April 2022.
- 4UOB Macro Note – China: 1Q22 GDP Beat Expectation But Downside Risks Dominate, 18 April 2022.
- 5The yield curve reflects the gap between short- and long-term bond rates. A steep upward curve when long-term rates are higher than short-term rates often appears during the expanding phase of an economy, while the inverse indicates growth contraction. An inverted yield curve, which is rare, occurs when yields for short-term bonds rise above long-term debts. That would spark concerns of sharply lower growth in the near term as higher interest rates crimp growth.
