The challenges ahead

Geopolitical uncertainty will continue to be the main factor influencing the global outlook. How the Ukraine war evolves will have an impact not only on oil markets but also on grain prices that are driving food inflation. There is also uncertainty surrounding the new Covid-19 wave in China. An extension of lockdowns could mean more ships blocked at Shanghai’s port, currently at record levels. There are also questions surrounding the resilience of corporations. In recent years many of them have focused on reducing costs rather than increasing their market share. Will they have the capacity to deal with higher demand or invest more in their business? Additionally, no-one knows yet what the impact of higher raw material costs will have in a context of low margins. These companies may find that they must invest in stronger supply chains by building factories in more expensive regions closer to home. This is likely to drive up their operating costs, contributing to the inflation loop.

Borrowing and fundraising could suffer from crowding out effects in capital markets. Traditional lenders have some spare capacity but what happens if they’re tempted back to public debt? Now that yields are positive again, institutional investors are showing signs of a preference for public bonds.

A different approach

Despite the unprecedented geopolitical tensions, there are reasons for optimism. Governments and corporates appear to have learnt some lessons from the 2008 global financial crisis. Unlike in 2008, governments and global authorities have acted fast to pre-empt a crisis, injecting funds equivalent to 1% of global GDP to shore up economies through central bank bond-buying programs and the EU’s NextGen investment program, which will provide member states with a war chest of as much as €800 billion. Individuals are also better placed. Support measures during the pandemic, including employment and rent guarantees and the stronger savings generated during lockdowns have left many people with a cushion to weather the cost-of-living crisis. Corporation have reduced their debt levels significantly since 2008, while many also received state support through cheap loans that helped them ride the pandemic’s worst effects.

The measures taken to contain the economic fallout from the pandemic have inevitably had an impact, with public debt at record levels. But there are factors which mitigate some of the concerns. The impact of higher financing costs will take some time to become apparent. Moreover, higher inflation is driving up government revenues while also reducing the nominal value of the debt. Ultimately, the global recovery will depend on the current inflation spike being transitory.

Global trade has already shifted toward a more protectionist approach. Economies could be affected by the shortening or relocation of supply chains to avoid shortages. Additionally, we have yet to see how the sanctions levied against Russia will impact on the global economy. Global trade could be set for a reality check.