Four Mega-Trends Shaping the 2022 Outlook and Beyond

The global macro environment is ripe for EM assets outperformance as a combination of stronger growth in China, the end of exceptionalism in the US and less uncertainty on US interest rates, lead to a strong backdrop for EM assets.

China’s GDP growth is likely to bottom in 1H 2022 after a strong slowdown in 2H 2021, led by real estate and energy crises. China is likely to ease monetary policy more aggressively and support local governments, small businesses and individuals via targeted fiscal policy measures. Policymakers are also likely to engineer a soft landing in the real estate sector by incentivising banks to extend developers’ debt maturity profiles, easing macro-prudential measures and promoting consolidation. A more balanced Chinese growth will support EM economic activity during 2H 2022, including equity markets. In Asia ex-China, the massive increase in industrial production is boosting capital investment across the region. In the US, the fear of interest rate hikes will give way to effective hikes. The Fed will most likely remain behind the curve, keeping real interest rates at negative levels. Historically, EM assets performed poorly during the periods preceding rate hikes (fear of hikes) but outperformed when the Federal Reserve (Fed) is effectively hiking rates. Next year may also mark the end of US exceptionalism, which started in earnest when the Donald Trump administration implemented pro-cyclical fiscal easing via tax cuts for corporations.

Biden’s overly generous Covid-19 grants to the population extended the period of US exceptionalism. Continuous pro-cyclical fiscal stimulus led the economy to overheat pushing inflation higher in 2021. From 2022, structural factors are likely to keep inflation elevated. The inflation overshoot is already constraining Biden’s progressive agenda. In 2022, US politicians will focus on the mid-term elections in October, when Biden is likely to become a lame-duck president. In EM, commodity exporters from Latin America to the Middle East and Africa have tailwinds from stronger terms of trade, thanks to higher commodity prices. Therefore, EM external accounts are in a strong position, with several countries that usually run external deficits now running current account surpluses. After nearly 10 years of underperformance, valuations are extremely compelling and investor positioning is extremely light across local currency assets. Countries that manage to implement solid reform agendas and/or consolidate their fiscal deficits (similar to Indonesia, Ecuador or Angola) will benefit from strong investment from both local and foreign investors.

The outlook is composed of five sections: Section 1: Global macro review of 2021 and its repercussions in 2022 Section 2: EM performance across different cycles Section 3: Scenario analysis for EM debt total returns from 2022 to 2026 Section 4: 2022 outlook for China, US, EU and Japan (G4) Section 5: Four mega-trends to watch in a new macroeconomic regime.