Summary

The 2021-22 recovery has been the most rapid on record; global overheating conditions have developed with Developed Markets (DM) central banks in denial for much of 2021 (and, in some cases, 22Q1). China is on a different path: a role reversal with DM from the years after 2009. DM inflation is at risk of becoming seriously embedded for the first time since the 1970s. The current DM conditions are very similar to those that prevailed in 1973; Phil’s working assumption is that war effects will fade, although an energy dislocation is a major downside growth risk for 2022 Q4. Fiscal policy was used well in the 2020 recession and 2021 recovery, although the Biden stimulus in Mar-Apr ’21 was too much; much of the automatic contraction has already been completed, by contrast, the monetary response has lagged. An outside-in tightening process began in Emerging Market (EM) economies and is well-advanced. The DM process has just begun, although markets have done a much better job of pricing in the coming tightening (for 2022) in recent weeks. Central banks are stumbling towards neutral, which is probably higher than both they and the market currently believe it to be. Past accidents have led the private sector to build in much more resilience. A continuation of the hiking cycle into 2023 and an eventual recession in 2024 is the modal scenario. Bonds need to handle: (a) higher policy rates in the future; (b) a higher term premium from QT and rising global policy and inflation risk; (c) a lagged adjustment in sticky inflation expectations in response to an ex-post inflation tax. Equities need to handle: (a) higher bond yields; (b) a cyclical squeeze in earnings; and (c) an end to the Greenspan/Bernanke/Yellen/Powell put.

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