THE year 2021 was a year full of surprises if we may conclude. Just when the global economy was starting to get the hang of the pandemic by inoculating the population and restraining the possibility of outbursts, a new Covid-19 variant emerged by the end of November, turning the markets topsy-turvy once again.

       Investors unloaded risky assets and flocked to safe havens as Brent slumped by as much as 11.5% while WTI dropped by 13.1%. The Dow Jones and S&P 500 fell by more than 2% on the same day and on the other hand, the Japanese yen firmed up 1.7%.

       Omicron, the newly discovered variant, was found to be much more transmissible than its predecessors, triggering another set of fears for policymakers on the possibility that it could undo the recovery progress that the global economy has made so far.

       Furthermore, the discovery of Omicron happened in the midst of policymakers, both from the central banks and federal governments, struggling to address questions relating to surging inflation pressure, such as whether it was transitory or not.

       Evidence of higher input prices pushing consumers’ prices became more apparent and persistent, while eroding consumers’ purchasing power at the same time. Also, combining higher inflation with record low nominal rates, these caused real rates to be in the negative zone and ultimately, taking the shine off investment returns.

       Based on data, when annual consumer prices in the United States surged by 6.8%, its fastest pace in 40 years in November, more heat was directed towards the White House and the Federal Reserve (Fed). The same tear-jerking inflation figure was also seen everywhere else; inflation in the eurozone soared to 4.9%, which is the highest since euro was introduced, and the UK posted its highest inflation rate in 10 years at 5.2%.

       However, the sentiment seemed to improve towards the end of year as market players reignited their risk-on mode during the last week of 2021. Early studies and data on Omicron revealed that people who fell ill due to the Omicron variant were less likely to become severely sick and hence less likely to be hospitalised than those who contracted Delta.

       As more booster shots were offered by drug manufacturers, complementing existing vaccination plans, the threat of an Omicron outbreak subsided. As such, the dollar index remained high and posted a 7.1% gain for 2021. Interestingly, the Chinese yuan was the best emerging market currency in 2021 as it registered a 1.6% gain after rising 6.3% in 2020.Central banks’ 2022 outlook

       Against the backdrop of high inflation, a spreading Omicron variant and uneven vaccination access, we expect to see a mix of central banks’ policies being laid out in navigating 2022. Some may still struggle to ensure that the local economy would not be derailed by the pandemic while others are seen to be pivoting towards containing inflation.

       Unsurprisingly, the Fed, which is the US central bank, has dropped the “transitory” narrative and shifted its stance to combatting a surging inflation. The decision was made during the last FOMC meeting in 2021.

       Hence, we expect the Fed will likely tighten its monetary policy at a faster rate as it has prepared a plan for tapering asset purchases process to end by March 2022. This will set up an early start to a rate hike cycle compared with previous expectations supported by the fact that the Fed having already met its average inflation goal, with the labour market most likely at an almost full employment.

       Also, according to the meeting minutes, officials were on board with three rate hikes in 2022 and another three in the next. Therefore, we can expect that the rate will be raised as soon as the tapering process ends or perhaps even before that.

       In the same meeting, officials had also started discussing on quantitative tightening, shrinking the Fed’s overall asset holdings of almost US$9 trillion (RM38 trillion) that had been surging since the start of pandemic. While officials had not make a final decision on when it will happen, we expect it to become one of the main topics for the upcoming meetings in 2022.

       Nevertheless, we are watching for any delay or change in the projection based on the existing pandemic development. If the Omicron variant or the emergence of another new variant of concerns turns out to be more dangerous than what we initially expect, we foresee the Fed delaying the rate lift-off plan.

       Although the rise in US Treasury yields and tapering, and rate hikes expectations will inevitably put pressure on its European counterparts, we see no reason the European Central Bank (ECB) making any sudden turn in its dovish tone.

       Unlike in the United States, the European continent already faced another round of the pandemic outbreak when Omicron was first discovered. Just after several weeks, European countries found themselves overwhelmed by both the Delta and Omicron which in turn, caused authorities to reimpose restrictions, and ultimately constraining the recovery progress.

       Combined with the ECB’s new inflation framework, this suggests that the policy will remain easier for a longer time. Furthermore, ECB president Christine Lagarde said in one of her statements that rate increases in 2022 is still “very unlikely”. The ECB will slow down the pandemic emergency purchase programme for the upcoming months before it ends by March 2022 but the regular asset purchase programme will be boosted temporarily to assure investors that the financial condition will not tighten anytime soon.

       Based on recent development, European countries are in the crosshair of higher inflation and slower growth which can be proof to be a massive headache for policymakers and maintaining current accommodative policies seems the only choice they have at the moment.

       On the other hand, the Bank of England (BoE) managed to surprise the market and became the first major central bank to raise interest rate despite the spillover of rising Covid cases in the UK. During its last meeting in December, the BoE started the cycle of tighter monetary policy by raising the key rate to 0.25% from record low of 0.10% since the pandemic started. This came as a surprise albeit subdued, after it kept the rate unchanged in November, defying market’s expectations of a hike.

       So far, the British government had not imposed new and stricter restrictions as studies showed milder symptoms of Omicron, shrugging off the new variant fear. Based on policymakers’ responses so far, we project that there will be more rate hikes by the BoE throughout the year, and possibly raised to 1% by November 2022.

       As of now, we do not expect central banks to stray too far from the projections based on confirmation that Omicron only inflicts mild symptoms compared to its predecessors, expectations of no new mutations of Covid-19, and the inflation level kept at the current level.

       Any sudden change in these factors and an abrupt pivot of stances can increase the risk of policy mistakes by central banks which can exacerbate the lingering pandemic-induced recessions in global economy.For FX enquiries, please contact: ambank-fx-research@ambankgroup.com. For Fixed Income enquiries, please contact: bond- research@ambankgroup.com