2022 will be a major turning point for central bank policy, growth, and inflationary pressures. While the environment will be more volatile and challenging, institutional risk appetite will need to be recalibrated in anticipation of risk hotspots and particularly mindful of early warning signals.
2021 ended with the Omicron variant triggering market turmoil, disruption in supply chains and rising prices. While the global base case GDP growth consensus of greater than 3.5% remains intact, the base case assumptions have since changed, notably with respect to inflation. This is evidenced by the shift in the global central banking narrative from “transitory” (inflation) to “optionality” (to tighten monetary policy).
The uncertainty surrounding the timing of rate hikes will have a widespread impact on the broader economy. The critical question will be whether the expected rate rise will be able to offset the growth in inflation, which up until now, has mainly been a function of supply chain disruptions. The emerging question is the impact of rate hikes on over-burdened businesses and households. Each rate hike will have a greater impact on the debt servicing and spending power of each borrower. Will it be affordable and manageable?
Markets are also in a fix to better understand phasing-out of the quantitative easing. Within this context, the key question is whether the Fed’s policy would still be accommodative as growth decelerates.
Lastly, can the markets expect central bank bailouts and if so, under what circumstances? As the fixed-income market moves back in the hands of investors, the yields will likely go up from the current negative yields, thus causing volatility.
To tackle uncertainty and protect balance sheets from large shocks, robust scenario-based stress testing will be more critical than ever. To build and maintain resilient credit portfolios, BBA’s Scenario Frontier uses next generation technology to apply a variety of scenarios across regions and market cycles to determine loss bearing capacity and to recalibrate the headline risk appetite using regulatory and customized stress tests.
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