taylor: let's take a look at how equities started the trading week. we came down a little lower, but friday we had our 67th record high for the year on the s&p. everything this week is about inflation-adjusted returns. that's where treasury is after inflation, losing about 10% as we push forward to a federal reserve that meets on wednesday. "what'd you miss" is next.

romaine: over the next 30 minutes, we are going to focus on the big risks ahead in 2022. bloomberg economics looks into the crystal ball. we are going to tell you what they found as they factored in central banks, inflation, covid, politics, and other elements that haunt the global economic recovery. investors -- if investors can figure out the answers, i guess they are the winners. kailey: so many potential downside risks remain. the question is if the market will look through it. we have been asking our guests about the big risks to the market over the next year. take a listen. >> omicron, inflation, and overextended markets. >> the pandemic. >> covid. >> covid and covid policies.

>> the pandemic and geopolitical risks. >> there are warning signs, inflation, other political risks around the world. >> geopolitics of china, russia, and iran. >> we are in a much more volatile time. >> 2020 two is another year of rebuilding, and it is going to be choppy. you have supply chain issues. >> what is valued at such a level that will come down. i'm not sure the market is ready for three interest rate increases next year. >> if fed efforts to slow inflation lead to recession, all of those things are sources of risk for the market. kailey: let's bring in our chief economist, tom, to walk us through some major risks he sees on the horizon. you heard a lot, ranges from the

buy risk to a variant to inflation to a federal reserve that might be behind the curve. what is the key risk you are looking at for next year? tom: i think those cuts captured a bunch of the big ones. the virus, prices in -- the virus surprise dust in 2020 and again in 2021 with the delta variant taylor: now -- variant. now omicron surprised us again. that could go two directions. if omicron turns out more contagious but less deadly, that could be an upside, a cheap inoculation that gets the global economy back to something like the pre-pandemic normal. if it turns out to be more contagious and more deadly, like delta plus, we are looking at more lockdowns, more supply chain stalls. that means a much more challenging 2022. romaine: the other big risk is

the inflationary pressures. there was a massive increase in consumer prices in the united states and a lot of other countries as well. tom: that's right. our best case for inflation in 2022't g to be driving price gains, reopening is not going to be driving price gains. there will be a higher basis for comparison. by the middle of 2020 two, inflation is coming back down towards fed, ecb, bank of england targets. let's think about where we were a year ago and what we thought about inflation then. if you asked economists at the end of 2020, what is inflation going to be at the end of 2021, they would say 2%. here we are close to 7%, so clearly a lot of uncertainty, risks. wages and expectations could

force inflation higher. gas prices with russia and ukraine tensions could force inflation higher. kailey: how much is the central bank reaction function to inflation and the covid-19 and its potential growth implication going to be the driving force for the year ahead? tom: as larry summers mentioned in those clips, it would be unusual if the fed tightening cycle did not have an impact on financial markets and an impact on the economy. we have got the s&p, even after recent falls, still extremely heady. we have u.s. real estate prices extremely elevated. and we have the fed probably going to accelerate its taper, creating a space for a rate hike potentially as early as march next year, potentially looking at three rate hikes next year.

that combination of very elevated asset prices and a fed that feels behind the curve and needs to accelerate to catch up, that's a toxic combination. kailey: white, on the flipside, could go right? tom: we mentioned in as a potential upside risk. it is also possible some pandemic savings, which consumers in the u.s. and europe are sitting on, start getting spent more quickly. you can imagine a goldilocks scenario where omicron turns out not very deadly, people are sitting on savings, they decide to continue spending on goods, splurge on some services, the holiday they wanted, the meal out at a luxury restaurant, and that catalyzes a stronger than expected recovery in 2022. there are also possible upside risks for emerging markets.

governance has brazil and turkey and other em's into trouble, lack of confidence in political leaders has triggered drops in em currencies and volatility in em markets. there are elections looming in brazil. turkish selections could potentially be brought forward. that could be a catalyst for the return of higher governance standards and the return of stability. romaine: tom orlik at bloomberg economics. some of the risks ahead for 2022. we are going to take a look at the markets here. a lot of risk seems tied evaluation. we talk about inflation. this chart is the long-term p/e ratio, a slightly different pe metric, which is right now around 37. the red arrow goes all the way to the left. kailey: we call it the

horizontal access. romaine: i was talking about the period of time. kailey: but on an inflation-adjusted basis, does that chart look different? does it look less bubbly if we are thinking about these assets and how to value them? kailey: anyway you slice it, this market is expensive. romaine: let's get the opinion of our next guest. he is a bloomberg opinion columnist and also a founder of unison advisors. you always do great research, putting things into context. when you look at that chart, does it show that on a historically relative basis we are in overvalued territory? >> thanks for the kind words. i am not a financial alarmist

and often i tell people to relax and take the long view, but i am concerned about this environment. it seems it is the most speculative environment in my adult lifetime, which does include the dot com era. it is in line with the numbers i looked at, whether you are looking at the stock market, which is by some measures the most expensive ever, but approaching the levels of the.com era. you have real estate cap rates fairly above treasury rates. you have wild speculation on all kinds of stuff, which i am not against, but we have to acknowledge there is speculation on stocks, cryptocurrencies, and nft's. you see the potential for asset prices to tumble and cause problems to the broader economy. one of the things i look at in the speculative periods is the but brigade.

all the buts come out. but earnings are higher than they were then. that line of reasoning makes me very nervous. romaine: that is what taylor does all day when we have this debate. taylor: but real yields are so deeply negative still. we are talking about the 10 year rate -102 basis points. what do you make of the argument that as long as we stay this low, risk assets and equities will be ok? nir: to the extent that low rates are driving asset prices -- i looked at the historical data and could not find any correlation between the interest rates and long-term valuation of the u.s. stock market. you have had periods where interest rates have been low and valuations have been high and vice versa. you do hear a lot of people say they are bidding up asset prices because interest rates are low. to the extent that's the motivating factor, you have to

worry about what would happen if interest rates go up. that brings us to inflation. i still think inflation will go down. i don't think this is a longer-lasting problem. to the extent that it is, high asset prices are a serious problem because the risk is inflation hangs around, interest rates follow it higher, which they have historically, and that gives the into this to bring asset prices down. we could also get hurt by low interest rates. >> when our guest mentioned a vaccine, romaine's years perked up. let's do second derivatives. is it the level of rates or is it the pace at which the fed is raising them? if they go slow and steady, we have heard arguments equity markets are fine. if they move quickly, that's when you get caught on the wrong foot? nir: i think it's both. there is a level of interest

rates where asset prices go down. if you think about bonds, there is a certain term risk priced into the bonds. the higher the interest rate goes up, the more the term risk has to be replaced. but the speed with which they move is going to be determined by whether the market is reading the fed's movement correctly. if the fed moves more quickly than the market expects, repricing is going to happen more quickly too. ultimately repricing is going to depend on the level of the interest rate, not just the speed. romaine: when you hear from powell on wednesday and over the next few meetings as we get more clarity about the pace of the taper and whatever is going to be the start of the rate hiking cycle, some people say, maybe they are behind the curve. if you believe inflation is more persistent that first thought

and you look at 6.8% and the idea we are going to come in not that far from it in the next month, what ability does the fed have to get that under control if they are going to wait until may, june, july to raise rates? nir: one of the things they can do differently now from the past is they have quantitative easing mechanism that wasn't really in play to the same extent in the 1970's. they could just taper bond purchasing and not move interest rates at all and arguably have the same impact on the markets. romaine: that's a great point. i am curious, does this become less about inflation and more about cooling down the economy? i know they are intertwined, but the perspective at which the fed approaches this is going to have a material impact on how people in the market approach their

investment. nir: for sure. so far i think the fed is doing the responsible thing. you can't possibly know where inflation is going to go. if you look at the totality of the factors, if you look at the fact that inflation is global and a lot seems to be driven by supply problems, those things will pass. the pandemic will pass, supply lines will reopen and start running smoothly again. the question is, where does inflation come from? it's hard to see where demand continues to be supported. by my count, half the people in this country are still not making a living wage. when the stimulus and pandemic savings run out, how does demand hold up? there is at least an equal argument that inflation will pass and the fed, not knowing which it is going to be, is saying, we will start tapering first, see what impact that has, look at inflation, and if that

is not enough, we will raise short-term interest rates if we have to. they are not there yet and the market says, that does seem reasonable, which is why you see the breakeven rate at 2.5% to 3%. romaine: we will catch up with you hopefully before the year end and get more clarity from the meetings this week. we are going to continue this conversation today and talk about the fed lift off, what the risk is for emerging markets. remember those? taylor: they are ahead of those when you think about where they are in the rate hiking cycle. we heard that a lot from shery ahn. romaine: they are ahead of us in inflation too. we are going to get some expert commentary from emily weis. she is going to be joining us in just a moment right here on bloomberg. ♪

romaine: today we are focused on the big risks to the global economy coming up in the next year. bloomberg economics put together a list of the most vulnerable emerging markets based on factors like external debt and account balances. taylor: i said they were ahead of us in raising rates. you said they were also ahead of us in inflation. maybe they are ahead in debt, vulnerability as well. how rising rates impact that is interesting. kailey, give us the top rankings the team has compiled. argentina, turkey, brazil, these are countries where we have talked about their currencies, the independence of central banks, you name it, political events. kailey: i just got back from a

trip to argentina and every person i spoke to talk to me about inflation, regardless of where they were, what field. it dominated the focus. even as central banks are moving toward tightening in these emerging markets, you are not seeing it impact inflation or support the currencies. let's get more with emily weis, emerging market strategist at state street. we can talk about how these emerging central banks are ahead of the fed when it comes to tightening. what is the impact on these economies when the fed does start to tighten? emily: they have had a head start on this process, something you covered a lot. emerging market central banks did not have the luxury to ignore inflation for as long as the fed has. because of that they have been more proactive. we are seeing impact on the growth expectations for next year, which is starting to decline for the likes of brazil.

when the fed starts reducing accommodations, that will tighten monetary conditions. that tends to be a point for risky assets and also em. this year we have already had weakness in the em space as fed pricing has been tightened. we are still thinking there is more headwinds to come, particularly if inflation does tend to be more persistent in the u.s. and if the fed is more hawkish. romaine: a lot of times we talk about em as just a group and we get folks like you who say, this is a time of different countries and regions with their own issues. i'm wondering if this time is different. given the inflationary pressures and covid issues, maybe we see more correlation in the performance of some of these em nations. emily: there has been a little of that lately. i still think there are opportunities within the pack

and we are looking at a country by country basis. as much as inflation has been global, there are places the situation is better than others. india and indonesia stand out as having some inflation but not to the extent we have seen elsewhere, and central banks that have been more cautious when it comes. to tightening a lot of latin america, brazil, argentina, even mexico, seeing the impacts of high inflation. there are still country specific stories headed into next year, particularly as we get china easing up on policy and providing more support. that is set to benefit asian nations more than the rest. >> it is interesting when we are talking about the relative value of the u.s. what many expect is the stronger dollar, but then you look at em and if they are ahead of us in terms of the rate hike cycle, the relative attractiveness of yields when you think about

capital flow, where do you see that relative value? emily: it has been interesting to watch that picture evolve. i was on six months ago and we were talking about looking at which countries would normalize first, seeing that as being the impetus for currency strength. that has not quite panned out as cleanly as expected. we have seen the correlation between two year yields in the em space and currency strength has been weak at best for brazil, south korea, south africa. it has actually been negative. higher yield has not translated the currency strength. looking forward, that relationship is going to continue to be difficult until we see inflation coming down in emerging markets. real rates are still low across the board. we think there will be a time next year when we see that turn, as inflation starts to come

lower and we can go forward. >> really appreciate your time and perspective, emily weis, emerging markets strategist at state street. she is wonderful. i know we will get to our final thoughts next. you are so excited. really the divergence -- and we paint a broad brush -- and it is very diversified. that is next. this is bloomberg. ♪

romaine: wrapping up our coverage today of the biggest risks to look out for in 2022. inflation is at the top. one thing we did not get to is the food costs and food stress. talk about sudan, yemen, algeria, egypt and the potential for unrest. kailey: we talked about the

geopolitical, emily weis mentioned it as well, not to mention the central bank risk as well. taylor: we talk so much about core inflation and strip out food and energy, but that is what people feel at the end of the day. romaine: that does it for this day. have a good evening, everyone. this is bloomberg. ♪

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