5 Key Challenges to Watch Driving the 2022 Financial Outlook

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If any of us had an actual crystal ball to give us the 2022 financial outlook, we’d be billionaires… but the reality is there are a lot of unique, atypical, and historically unprecedented economic and financial data points right now. So, what can we expect economically and financially in 2022? There are 5 key challenges I plan to keep tabs on as we head into 2022 that will likely dictate where the year is headed: inflation, interest rates, employment, disposable income, and the wild card that we seem least able to predict, Covid.

What Will Drive the Financial Outlook for 2022?

The last two years have been full of economic turmoil driven largely by an illness we at first knew little about. Lockdowns, shutdowns, remote schooling caused significant economic distress and rapid employment loss, from which we are still trying to recover. The US government acted quickly to offset these economic hardships, flooding the economy with cash via direct stimulus payments, expanded Federal unemployment benefits, and advanced child tax credits, while the Fed held interest rates near-zero and added an unprecedented amount of money to the money supply to hold long-term interest rates at record lows too. However, those actions also had the negative consequence of producing 40-year high inflation.

And in spite of everything happening in the world, the virus, the new variant, inflation, the low-interest rates, and likely the flood of cash in the economy, drove the market to its third consecutive year of double-digit returns, with the S&P 500 ending the year up +26.9%, more than 3x the average annual return of the market over the last 100 years.

As we head into 2022, we know more about the virus but the impacts of the pandemic linger as we currently endure the 4th wave. The Fed has plans to raise interest rates to rein in inflation. The Federal stimulus funds have all come to an end. So what will happen to the economy as it has to stand on its own two feet?

These 5 economic factors are likely to determine the financial outlook in 2022: 1) rising interest rates and 2) the impact on inflation, 3) the labor market and 4) its impact on disposable income and consumer spending, and finally, the biggest wild card over which we potentially know the least and have the least control, 5) Covid, the potential for new variants, and how and when we as a country shift from a state of pandemic and panic to acknowledgment that this is now endemic and we need to find a way to live with it.

The Financial Outlook on Interest Rates vs. Inflation

The biggest direct impact on every household’s family finances over the last year is inflation. As of December 2021, based on the Consumer Price Index, prices are now up +7.0% in the last year. With 1/3 of household expenditures driven by commodity and energy prices, which have seen double-digit price increases in 2021, and many anticipating further inflation in shelter costs given rising home prices and housing shortages, many are concerned the Federal Reserve waited too long to act.

Related Post: 5 Factors Driving Higher Inflation

The Federal Reserve, the central bank here in the United States, aka the Fed, is tasked with creating monetary policy to serve a dual mission: promoting full employment as well as price stability. Successfully doing those two things supports a healthy, growing economy.

At the outset of the pandemic, the Fed acted quickly, immediately dropping short-term interest rates near-zero as well as using their balance sheet to serve as a large buyer in the US Treasury market and mortgage-backed security market. This helped keep long-term interest rates low, and provide access to credit through the massive loss of employment and business closures we experienced early in the pandemic.

But it also more than doubled the size of the Fed’s balance sheet and the money supply in less than 2 years.

Despite signs of rising inflation through most of 2021, the Fed held firm to accommodative monetary policy – low-interest rates and continued use of their balance sheet. The thesis was that inflation was transitory, a function of temporary production shutdowns and supply chain bottlenecks created from the recovery. The Fed pointed to the labor market still in recovery as further rationale.

But late in 2021, the Fed definitely changed its tune. Inflation began accelerating, impacting more than just energy prices, and spilling over into wages. It became more evident that the labor market wasn’t suffering from the unwillingness of employers to hire (which is what low-interest rates help stimulate), but from a lack of labor force participation.

In September, the Fed warned accommodative policies may soon be ending. In November, they announced the first plans to begin reducing open market asset purchases on a timeline that would bring them to zero by June 2022.

In December, just 6 weeks later, the Fed indicated they were accelerating that plan, bringing asset purchases to an end by March, implying they were paving the way for short-term interest rate increase to begin by then as well.

In the last week, testimony by both Fed Chair Jerome Powell and Fed Vice Chair nominee Lael Brainard before the Senate for their confirmation hearings have stressed that reining in inflation is their shared goal and top priority:

But inflation is too high, and working people around the country are concerned about how far their paychecks will go. Our monetary policy is focused on getting inflation back down to 2 percent while sustaining a recovery that includes everyone. This is our most important task.

Federal Reserve Governor Lael Brainard,
Before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, Washington, D.C., January 13, 2022

What does this mean for the 2022 financial outlook? It means you should expect interest rates to start to rise. And in fact, we have already seen them start to do so over the second half of 2021. The market generally expects the Fed to raise interest rates 3-4 times over the course of 2022, with increases of ~0.25% each time. These increases impact the short-term, overnight lending rate between banks while setting the tone for the remainder of the yield curve, which has its rates determined by the bond market.

But it’s also important to keep perspective – interest rates will rise, making borrowing more costly, but even with increases, interest rates will still remain near record low levels relative to history. Let’s hope the increases are enough to take the edge off inflation – which is far costlier and unavoidable to your everyday purchasing power.

Key Dates
The Fed’s next Federal Open Market Committee Meeting is scheduled for January 25-26, 2022
The PCE Price Index, the Fed’s preferred measure of inflation, is due out for December 2021 on January 28, 2022.

The Financial Outlook based on the Labor Market and Disposable Income

Over the last two years, the Federal government stepped up in a big way to offset the impacts of the pandemic on the overall economy and most specifically, your family finances. Why?

Because the US is an extremely consumer-driven economy, with 2/3rds of GDP driven by consumer spending. When millions lost their jobs overnight in March 2020, the government stepped in with direct stimulus checks, expanded unemployment benefits, paused Federal student loan payments, and most recently, advanced and expanded child tax credits. This kept disposable incomes up, supporting consumer spending, and preventing a far worse economic recession.

However, all of those benefits have now officially ended, save for Federal student loan forbearance, which has now been extended through May 1, 2022. This means consumer spending is now reliant on disposable income largely just from employment. Will it hold up in 2022 in the face of reduced labor participation rates and rising inflation?

If we look at the monthly employment data from the Bureau of Labor Statistics, we can see the abrupt and dramatic decline in employment at the start of pandemic lockdowns. More than half of those jobs were quickly recovered, though the job gains have slowed in the second half of 2021. And as of December 2021, we remain 3.6 million jobs short of pre-pandemic peak employment. This means there were 3.6 million more people working in February 2020 than there are today.

Despite that, the headline unemployment rate in December was down to 3.9%… though that doesn’t tell the whole story. The unemployment rate is low, despite millions fewer jobs, because the labor force has declined. Today, there are 2.3 million fewer people in the labor force – those employed or actively looking for jobs – than pre-pandemic.

If we look at the demand side of labor – or employers looking to hire – we see huge demand for labor. There are more job openings in recent months than ever before reported in the history of the data series that tracks this information. As of the end of November, there were 10.4 million job openings. This huge demand for jobs vs. a shrunken labor force is driving up wages. Nonsupervisory workers saw average weekly earnings increase by +5.8% over the last year.

Today’s labor market issue isn’t a shortage of employment opportunities, which is what low-interest rates would help stimulate – it’s a shortage of people seeking jobs or qualified for the record level of job openings there are. And it’s fueling a record-breaking number of quits – as workers take advantage of the plethora of opportunities and rising wages. This is also beginning to play a role in inflation – as wages push costs higher, producers pass those costs on to consumers. Labor shortages also do not help in alleviating the supply chain bottlenecks, which also fuel inflation in the face of higher consumer demand.

And what’s fueling that demand? Consumers flush with cash. Normally, in a recession, falling demand leads to job losses, which lowers incomes, which fuels further demand declines, deepening the recession. Government stimulus helps stem the declines and launches the recovery.

The problem today is that 1) this recession was caused by a forced decline in demand due to lockdowns, which created pent-up demand in some areas and shifts in long-established consumer spending patterns. 2) While we had massive declines in employment, disposable income, at least in aggregate, never actually declined, and in fact, remained above the long-term, upward sloping trendline throughout the last 2 years. This is a result of the federal government’s stimulus checks, expanded unemployment benefits, and advanced child tax credits.

This then fueled increases in savings rates, and those savings are still funding elevated levels of personal expenditures, increasing demand against struggling supply chains, driving price inflation. Elevated levels of saving could potentially also enable some to remain out of the labor force, when they otherwise may have had to return already.

In 2022, the labor market question isn’t how do we get employers to hire… it’s how do we get people to go back to work! The ending of many federal financial benefits, the last of which ended in December with the advanced child tax credit payments, is one step towards creating the financial need for people to return to work. But hurdles remain, especially for women and mothers: access to affordable childcare, certainty around schools, as schools around the country are returning to remote learning in the midst of this 4th wave… which leads me to the 5th major factor which will determine the financial outlook for 2022.

Key Dates
The Employment Situation Report is released on the first Friday of every month.
Weekly Jobless Claims, representing new unemployment claims, are reported every Thursday.
The Job Openings and Labor Turnover report for December will be released on February 1, 2022.
The Personal Income and Outlays report from the Bureau of Economic Analysis for December is due out January 28, 2022.

How Covid Impacts the Financial Outlook for 2022

As we look ahead into 2022, covid and how we choose to respond to it, both individually, as well as medically and state and federal government responses, remains the wild card.

Absent covid concerns, I have little doubt the Fed would raise rates as planned and as much as needed to rein in inflation. Absent covid concerns, I believe there would be less of a labor shortage. More people would eagerly return to work – childcare would be more accessible and affordable. Moms wouldn’t be worried about school closures, quarantines, and would have less hesitation about returning to the workforce. Absent covid concerns, it would be easier to alleviate supply chain bottlenecks and predict how long it would take for supply shortages to end.

But sadly, Covid persists. And the Omicron variant, first detected the week of Thanksgiving, has now led a 4th wave of the virus, driving the highest daily case numbers the US has seen yet, by a magnitude of 4x.

The good news? Early indications from other countries, and now the data coming from here in the US as well, demonstrates that the Omicron variant is less severe, resulting in fewer hospitalizations and deaths. Yes, hospitalizations and deaths are increasing – but cases have skyrocketed. The rate of hospitalizations and deaths is falling… and that’s relative to reported cases, which we know are likely an understanatement of actual cases currently given the increase in at-home testing and the inability to get lab testing in a timely fashion in many parts of the country. Here in Connecticut, it can take a week or more to schedule a PCR test currently.

The astronomical rise in cases in recent weeks, as well as the seemingly reduced severity of the latest variant, have already led to changes in CDC guidance on quarantines and have some countries around the world beginning to question whether its time to shift from treating this as a pandemic to acknowledging it is endemic, or “consistently present.”

The countries who make this transition soonest and most effectively – learning to live with and treat the virus most effectively – will likely see the most stable economies as we move through 2022.

How are these 5 challenges impacting your family finances and your financial outlook and plans for 2022? I will continue to update these key factors every week in the Monday Market Update, as well as other major indicators, to help keep you informed so you can make better financial decisions for yourselves, your families and your future!

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About Meghan

Meghan spent nearly a decade as a Financial Analyst, before spending the last 7+ as a SAHM to three little ones. She shares simple money tips for moms to help your family reach your financial goals by building a financial plan you can LIVE with! You can learn more about her background in finance, catch her daily on Instagram and Facebook, and her weekly live discussions in her community for Family Finance Moms.

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