Encouraging signs on Omicron

The Omicron variant has caused coronavirus cases to spike to their highest levels since the start of the pandemic in many countries. Thankfully, widespread vaccinations and potentially the reduced virulence of Omicron mean that hospitalisations and deaths have not followed suit. The next few months are still likely to be difficult: given the scale of infection, there could well be pressure on hospital capacity even with a lower rate of serious cases. However, looking further ahead, Omicron could herald the end of the pandemic as coronavirus becomes more of an endemic disease and less of a burden to the world’s health systems. This possibility helped equity markets rally strongly into year end.

Fed set to follow BoE’s interest rate lead

Central banks had an unusually busy December. The Bank of England raised its Base Rate to 0.25%, from 0.1% previously. We expect it will follow up with another 0.25% rise in February and then pause as inflation starts to moderate from current high levels. US monetary policy appears to be on a similar path, with a lag of several months. In December, the Federal Reserve indicated it would end its asset purchase programme by March and raise interest rates by mid-year. We expect one further increase this year. Equities have largely shrugged off the prospect of higher interest rates, though it may be apparent in the weaker performance of sectors that are particularly sensitive to liquidity conditions - such as early-stage technology. China stands out as the only major central bank that is likely to ease monetary policy this year, as the country contends with a significant slowdown.

Geopolitical disputes back on the agenda

Long-running international tensions subsided somewhat as countries turned inwards to deal with the pandemic. However, as the health threat recedes, several key flashpoints are coming into focus again. Ukraine is currently of greatest concern, with a significant build-up of Russian troops at its border. Developments relating to Taiwan and Iran are also worrying. While full-scale military conflict is not currently the most likely outcome in any of these situations, there are many other scenarios that could threaten global growth – including sanctions, tariffs and disruptions to energy supply. More generally, relations between the US and China remain tense and could flare up again in 2022 – especially with the US facing mid-term elections later in the year.

Portfolio positioning

Within our multi-asset portfolios, we head into 2022 with a neutral to overweight position in equities relative to our strategic allocation. Our forecasts for economic and corporate earnings growth continue to suggest maintaining exposure to the asset class. Our portfolios stand to benefit from ongoing economic recovery, though we remain focused on longer-term themes such as energy transition, technology and healthcare. Away from equities, we have a preference for alternative investments over fixed income. We continue to expect bond yields to rise from current low levels as central banks raise policy interest rates and inflation remains higher than pre-pandemic levels.

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