The Global Economy in 2022: A Year of Turbulence and Uncertainty

The Global Economy in 2022: A Year of Turbulence and Uncertainty

Dear friends,
The first three months of 2022 have been very eventful in global affairs. The concerns surrounding the global spread of the Omicron variant have faded and been replaced with the surprising invasion of Ukraine by Russian forces followed by the unexpectedly robust retaliatory economic sanctions imposed by the US and EU. As with all such conflicts we hope it ends quickly with minimal further loss of life and suffering.
Russia’s invasion and the response it has engendered will likely have a long term impact on global finances. Within the span of days after the invasion, in a move that surprised many political pundits, Russian entities were shut out of the global payments systems. Credit cards issued on major networks stopped working and banks lost the ability to settle US dollar payments. The size and scope of the sanctions along with the widespread denunciation of the invasion (led by US and EU nations) seemed to have caught Russia off guard as prior Russian-led conflicts (Georgia, Donbas, Annexation of Crimea) had not been met with such unified opposition. Despite all this, EU markets continue to purchase Russian conventional energy, a position that appears increasingly farcical as other sanctions are strengthened.
In response to these measures, over the long run, we believe major economies outside North America and the EU will develop parallel financial systems to insulate themselves from any such punitive sanctions. The hand-wringing over the demise of the dollar as a global currency is probably exaggerated (that will likely not happen over the next two decades). But eventually we believe other currencies will play a larger role in global trade. This is to be expected and is a dynamic similar to the one that occurred over several decades when the British pound was replaced by the US Dollar as the primary means of international settlement in 1944. In the short term, there is no other major economy with a stable currency that can serve such a purpose since most aspirants (apart from the Euro) are either too small or have some form of capital control to limit currency fluctuation. The Swiss Franc has historically been a neutral alternative, but Swiss participation in the recent sanctions partly undercuts this role in the future. The Euro meets the size and stability criteria, but the Eurozone’s close alliance with the US is similarly likely to give other major countries pause when considering it as a backup. Physical gold has historically been a medium of last resort, but these sanctions have targeted Russian central bank gold reserve holdings as well as currency. This makes it less likely that non-allied countries will maintain large gold reserves in US/EU financial centers. It’s not unreasonable to say that blockchain concepts will play a role in any newly developed payment networks. We think it is unlikely that major central banks adopt one of the existing, independent crypto payment networks. They are far more likely to develop a new system/currency using the same technology as the early independent networks.
Both China and India have been moving towards developing independent payment networks for small and large transfers. We see this trend accelerating and the decades-long uncontested primacy of US/EU systems and networks will likely fade. This was, of course, bound to happen at some point as the locus of economic activity moves back towards Asia.
On the economic front, Q1 saw the US record inflation figures at levels not seen for decades. Some of this is due to a spike in energy prices and other dislocation in global supply chains. Regardless of cause, the hike in price levels likely spells trouble for both equities and bond markets. The Federal Reserve is poised to embark on a series of quick interest rate raises, coupled with a rapid reduction in its balance sheet. These moves would shift a virtually uninterrupted 16 years of easy money policies. The combination of inflationary pressure and rising rates are likely to have a larger impact on long-tenured instruments such as long-dated bonds and speculative growth stocks.
While the economic environment seems primed for rates to run higher, the Fed does have a recent history of pivoting on rate hike policy. 2019 saw the Fed reverse course after raising interest rates steadily over 2017 and 2018. The Fed made three rate cuts in 2019 (Trump’s trade war was referenced as a reason) and then slashed rates again to 0 in 2020 when the Covid-19 pandemic took hold. If inflation ebbs, the economy falters or demand slackens, we could see the Fed backtrack on their rate tightening plans.
While stocks and bonds have gotten off to a rough start in 2022, alternative assets such as commodities and precious metals have performed well. Value stocks in industries such as utilities and energy have shown positive returns on the year while speculative technology companies are deeply in the red. We continue to recommend a defensive, diversified
portfolio that is weighted towards value stocks over growth. With interest rates rising in anticipation of the moves from the Federal Reserve, we’re starting to see some compelling opportunities in the bond space. Tax free municipal bonds are starting to look interesting
again for the first time since the bond market upheaval in Q1 2020. While many speculative growth stocks have come down considerably in price, we still think there remains risk for further downside. We expect volatility to persist in 2022 and will continue to look for opportunities in stocks and bonds as they present themselves.
Best,
Louis and Subir

The foregoing contents reflect the opinions of Washington Square Capital Management and are subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or constructed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. 

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