When Deutsche Bank Research last updated their world outlook in the wake of massive US fiscal stimulus packages and accelerating vaccinations, the baseline, they said was “a goldilocks scenario”, but one with significant inflation risk attached.¹

Nine months on, while a continuing robust recovery from the Covid recession still seems more or less intact, the risks around it have intensified substantially, observe Deutsche Bank’s Chief Economist and Global Head of Research David Folkerts-Landau and Peter Hooper, Global Head of economic Research.

In the report, World Outlook 2022-23: Dodging the Tempests (13 December 2021) their update summarises the setbacks but also some of the causes for optimism. “Our fears on the inflation front have been realised,” they note, and add that while there are good reasons to expect some easing from current “lofty” rates of inflation, “troubling signs of a more persistent problem continue to grow”.

As for the fight against Covid, this, they say, “has progressed less effectively than we had expected or hoped in March in the wake of remarkable initial progress in developing and disseminating vaccines”. A combination of new and more infectious strains of the virus and the “disappointing” performance in the take-up and distribution of the vaccines have taken some steam out of recent growth performance and near-term prospects, while adding more persistence to inflation risks.

“The latter effect has been more worrisome for G10 central banks and caused them to shift in a more hawkish direction recently, raising the risk of a quicker end to the current expansion than we have been envisioning,” they add.

The full 50-page report, available to Deutsche Bank clients, provides an in-depth analysis of the economic outlook, some observations on supply chains, commodity prices and a deep-dive into regional economies. Below is a summary of the key points.

“Menacing storm clouds have gathered around our outlook for the next two years. Inflation is pushing 6% or more in Europe and the US while central banks continue quantitative easing. A new and more infectious strain of Covid is spreading rapidly as vaccination rates lag. Supply chains remain clogged with delivery times and transport costs near all-time highs. Potential populist-driven political turmoil, climactic tempests, and geopolitical storms loom.

The odds of a shipwreck have risen dramatically as we chart a course through perilous waters. But timing recessions is very difficult until they are fast upon us. For now, a way can still be seen to the safe harbor of a relatively soft landing, albeit with some favorable assumptions and a modicum of good luck. Several factors work in our favour:

1. Omicron is so far proving less virulent than preceding variants and new vaccines are being developed.
2. A number of key measures of supply chain performance are now on improving trends, albeit gradual ones.
3. Other factors that boosted inflation, including sharp run-ups in energy prices and indirect tax hikes, have ceased or are reversing.
4. Central banks behind the curve are expected to move soon to correct this via timely tightening action. While historical experience suggests it is devilishly difficult to achieve a soft-landing, it can be and has been done.

Our baseline forecast has GDP growth as well as inflation continuing into 2022 with considerable momentum. We then see growth moderating to trend and inflation receding to desired levels by 2023, with the Federal Reserve lifting rates by mid-2022 and the European Central Bank by the end of 2023. See Figures 1 and 2.

Consistent with this macro view, we see an overvalued stock market moving slowly, with valuations declining as earnings expand at a robust pace. Longer-term market interest rates should rise for much of the year ahead as central banks lift off. Credit spreads will widen some and the dollar should strengthen. Finally, more OPEC output will depress oil prices.

As we have suggested, the risks around this favorable baseline outlook are considerable. Most important, the failure of inflation to recede as anticipated will put central banks in a more aggressive tightening stance, causing a sharply negative reaction in financial markets and most likely a significant economic recession.”

World Outlook 2022-23: Dodging the Tempests by David Folkerts-Landau, Peter Hooper, Deutsche Bank Research (13 December 2021)

Sources

¹ See 'World Outlook: Goldilocks with Inflation Risk' by David Folkerts-Landau, Peter Hooper, Deutsche Bank Research (16 March 2021)