At State Street Global Advisors, our Global Market Outlook captures what we expect to see as 2022 unfolds. We also believe that there is merit to considering alternatives to this base case — particularly scenarios that have a reasonable, if low, probability of occurring, and the potential to materially move markets. We call these scenarios Grey Swans.
Thinking about Grey Swans helps inform the risk-aware approaches we take across our portfolios. For the coming year, we have identified a set of Grey Swans to watch in 2022. To learn more about our thinking underlying each of these scenarios, as well as potential hedging strategies, please download “Five Grey Swans That Could Disrupt Markets in 2022” by Lori Heinel and Gaurav Mallik.
In this Grey Swan, the scale of stimulus deployed in Italy lifts the economy to the extent that growth there (and elsewhere in the periphery) outpaces that of Germany and the core of the eurozone, bolstering support for greater fiscal union. Taking the political leap of faith necessary for the eurozone to transition to a genuinely viable, independent and globally competitive entity, all sides shift from long-entrenched positions, such as on banking union and the mutualization of debt.
For investors, the appearance of sustainably higher output growth could drive a true re-rating of the eurozone equity market, underpinning outsized return potential. But the real transformation may be seen in the fixed income market where spreads could tighten and consolidate at low levels, making Italian and peripheral debt less speculative. Against this backdrop, the euro would also strengthen considerably.
The sustained surge in cryptocurrency prices in the last two years has coincided with more widespread acceptance of digital assets, translating into elevated ‘paper’ wealth. In this Grey Swan, demands for regulation of digital assets set in motion a market correction that spills over into traditional markets.
Heightened regulation should lead to an overall reduction in risk and speculation. If there were a dash for the exits in the digital world, however, the sheer size and scale of the digital asset market poses contagion risk. As digital asset valuations decline, capital would need to be raised and traditional assets would likely be the first choice to meet liquidity needs and to de-risk.
Inflation and interest rates remain the key macro risk in markets today. The entire capital market structure could be troubled as lofty valuations in many segments of the market have often been justified by the low and stable inflation and interest rate environment of the last two decades.
In this Grey Swan, markets perceive that the policy path is too slow, which brings inflation worries to the forefront. While short-term growth is steady, long-term forecasts would suffer. Higher inflation and a diminished growth outlook would increase equity risk premia. Equities would decline while long-term interest rates pick up, resulting in a positive bond-equity correlation. Under these conditions, most traditional 60/40 equity/bond portfolios would suffer greatly as bond prices and equity multiples would likely decline at the same time.
Higher energy prices function as a tax on consumers and businesses, reducing growth and earnings expectations, while their inflationary impact introduces risk of higher interest rates and greater monetary policy uncertainty. In this Grey Swan, we consider what could drive oil to $150 per barrel.
Demand for oil could surprise to the upside as improved COVID-19 therapeutics and ongoing vaccinations fuel a more complete recovery in consumer demand, business activity, and air travel. Conversely, supply could surprise to the downside as countries fail to reach expected capacity due to poor maintenance and infrastructure. On the geopolitical front, heightened risks are evident as Russian troops amass on the border with Ukraine. Against such a tight supply/demand backdrop, any kind of supply shock would send prices higher.
The surge in stablecoin circulation has pushed central banks to consider deploying their own digital assets. In this Grey Swan scenario, a major developed market (DM) central bank regulates an off-chain fully collateralized stablecoin, thus disrupting decentralized finance and bringing volatility to conventional finance.
The net effect of a first-mover DM-regulated fully collateralized stablecoin would likely see it draw in capital from global markets. Given that the first stablecoin would likely be US dollar based, this would exacerbate stress in emerging markets and complicate US Federal Reserve policy in the short term.
If cycles typically last five to seven years, history might suggest that we are in store for strong asset returns and little risk of recession for several years. This cycle is very unusual, however. Pre-recession output peaks have already been achieved and we anticipate the US unemployment rate to average just 3.7% in Q4 2022. Meanwhile, policy accommodation since 2020 has far exceeded historical norms. In this Grey Swan, a painful withdrawal of policy accommodation combined with the normalization of fiscal spending and the unpredictability of unusually powerful global inventory cycles threaten a premature end to this cycle. We consider the risks of this outcome to be non-trivial; this is a Swan dressed in a lighter hue of grey.
One key indicator to monitor is the US yield curve, which has been flattening since March 2021, and at this pace could become inverted in mid-2022. Inverted yield curves have typically challenged risk assets and portended recessions within 18 months.
Esther Baroudy, CFA
Senior Portfolio Manager, Fundamental Growth
and Core Equity
Matthew J Bartolini, CFA
Head of SPDR Americas Research
Matthew Nest, CFA
Global Head of Macro Strategies
Aaron R Hurd, FRM
Senior Portfolio Manager, Currency
Elliot Hentov, Ph.D.
Head of Policy Research, Global Macro
Simona M Mocuta
Chief Economist, Global Macro and Research
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