Expectations for 2022

by Sean Tweedie | January 5, 2022

Going into 2022 we remain optimistic that the worst of the fallout from the pandemic is behind us. As we stand, the DXY index (an index which tracks the strength of the dollar against a basket of major currencies) is sitting at 96, the midpoint between the highs of March 2020 and lows of January 2021. The DXY can also be seen as a proxy for safe-haven demand. This level of 96 reflects the heightened risk aversion in the market from the emergence of the Omicron variant, with the market rating it worse than the Delta variant but not as bad as the original outbreak. See Figure 1.

Figure 1
The Omicron variant does remain the greatest risk to economic growth in the near term. We have yet to see the full impact of the Omicron variant globally, especially on developed economies. However so far it appears to be less severe than originally believed, at least from a South African perspective. Unfortunately, as we continue to see infections rise, additional restrictions on economic activity are likely in many developed market countries (such as in parts of Europe).

On the plus side, we have two years of data on the virus and so stand in a better position, even when compared to this time last year. The world has also learnt to live with COVID. Pfizer has also suggested that a third booster dose of its vaccine results in a 25-fold increase in the antibodies that attack the virus. Additionally, a new vaccine to combat the Omicron variant will be available by March. Furthermore, vaccinations continue to ramp up around the world, especially in emerging markets. There are now many developed and emerging markets countries who have a higher share of their population vaccinated compared to the US. See Figure 2. This development has resulted in a subtle shift in growth estimates which are now increasingly favouring other countries relative to the US.

Figure 2

The path for global growth in 2022 is largely dependent on Chinese growth. China contributed 20% to global GDP in 2021 and will likely contribute a bigger share in 2022. See Figure 3. On top of the new risks imposed by the Omicron variant, Chinese authorities also face the fallout from the slowdown of the property market. China has made impressive progress in vaccinating its population over the past year. However, recent reports suggest that the CoronaVac vaccine which is produced by Beijing-based company Sinovac, may provide no protection against the Omicron variant. This may have severely reduced the effectiveness of China’s vaccination campaign. This makes it almost certain that China will maintain a zero-tolerance COVID policy for most of 2022. This significantly raises the risk of additional factory and port shutdowns – and thus higher shipping costs and imported goods prices for many markets.

Figure 3
One of the biggest drivers of a strong dollar this year (aside from rising interest rate expectations), has been equity inflows into the US. See Figure 4. The dollar tends to do well when US stock markets are outperforming their peers. Money tends to flow to capital markets with the highest expected returns. We could well see those sectors which have proven strong throughout the pandemic (particularly technology and healthcare) to keep driving up the stock market through the Omicron setting. This could therefore be a tailwind for the dollar. However, if we continue to a meaningful rotation of growth from the US to other economies, the stock markets of these non-US economies should pick up and therefore capital will flow out of the US and into these markets which would prove a headwind for the dollar.
Figure 4
From a technical perspective, the dollar tends to be a momentum currency (meaning past strength brings about further strength). It is for this reason that we may over the course of the next few months see a continuation of the dollar bull market. However, the dollar is reaching overbought levels with speculative long positions in the dollar approaching levels indicative of a reversal. Furthermore, in terms of valuation based on Purchasing Power Parity (PPP), the dollar is expensive by around 20%. See Figure 5. Although this is not a good model for the timing of a move, it does point to the direction over time on the premise that a currency will tend to move toward its fair value.

We think that over the course of the year we may well see the dollar push higher with the DXY potentially reaching 98. This would be the case where the fallout from the Omicron variant across developed markets proves as serious as markets are pricing in and we see a move towards safety. The growth in China and their response to the Omicron variant will play an important role here. If the Omicron variant proves to be less serious than what’s believed and so we don’t have significant restrictions on economic activity, we should see growth trend higher and rotate out of the US. In this environment the dollar will face a headwind and so will weaken again towards its fair value.

Figure 5

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