If 2022 confronted investors with stiff headwinds, 2023 is likely to be challenging as well. After all, ﬁnancial conditions are all but certain to remain tight and the fundamental reset of macroeconomics and geopolitics is continuing.
In 2023, energy prices appear to hold the most sway over the economy and markets.
But if we look to 2023 the most important question is: will inﬂation start to behave as economic activity slows? There are already convincing signs that inﬂationary pressures are moderating and will continue to do so in 2023.
The world speed is challenging; it’s dizzying and makes it hard to maintain perspective. However, as we have entered a new world order, a new strategic and diversiﬁed approach to business and investments is needed to be better prepared to face the challenges of the year ahead.
Short-lived and shallow recession in the Euro area
- As the economic consequences of the war in Ukraine fuel the strong inﬂationary pressures, consumer and business conﬁdence have remained subdued, while real disposable incomes are being eroded and soaring cost pressures are curtailing production, especially in energy-intensive industries.
- The negative economic repercussions are expected to be partially mitigated by ﬁscal policy measures.
- The Euro area is expected to avoid the need for mandated energy-related production cuts, although risks of energy supply disruptions remain elevated; over the medium term, uncertainty will decline.
- Economic growth is expected to rebound. The labor market is expected to remain relatively resilient to the coming mild recession.
- Overall, annual average real GDP growth is expected to slow down markedly, from 3.4% in 2022 to 0.5% in 2023, and then to rebound to 1.9% in 2024 and 1.8% in 2025.
- Russia’s invasion in Ukraine remains a major source of disruption, especially across emerging market economies, the war is fueling uncertainty about food security.
A mild but short recession is likely in 2023
- The US will experience a mild but short recession in the middle of 2023 caused by consumer and business spending falling because of rising interest rates.
- Anti-inﬂationary policies are curbing demand and tightening ﬁnancial conditions enough to start bringing prices down much closer to the Fed’s 2% inﬂation target over the course of 2023.
- Gas prices have fallen recently, but economists see energy prices rising again, particularly for heating. The Strategic Petroleum Reserve is low, which means there likely are not enough reserves available to help alleviate high prices should oil and gas spike again.
- There are more than 3.3 million workers missing from labor force participation rates and 4.3 million more job openings than unemployed workers. Businesses are still struggling to get the workers they need.
- In 2023, the US businesses should be prepared, and as always, for those unexpected events that come out of nowhere.
A fundamental reset
- The recent downtrend in inﬂation doesn’t mean that we will get back to the Fed’s 2% annual target soon. History shows it could take up to two years to get there.
- The decline in inﬂation is taking place without a sharp increase in the unemployment rate, which points to a higher probability that the Fed might engineer a much-desired soft landing of the US economy, a scenario that many thought very unlikely just a few months ago.
- The bottom line is that monetary policy is working as intended. It will take some time for the capital markets to normalize. In the meantime, the window of opportunity in the private markets should remain open for well-positioned capital providers.
Next year will be a long, hard slog
- 2023 may be one of the slowest years for global growth in decades: it will be at 1.7% next year, a big slowdown from the 6%+ growth of 2021 and a signiﬁcant drop from the 3.2% growth for 2022. Inﬂation will likely fall slowly, with consumer prices worldwide rising at a 4.6% average next year.
- Advanced economies are heading into a recession, led by the Euro area and the UK. The US will also likely contract across 2023.
The year ahead
- Looking at 2023, China’ growth drivers will be shifting from foreign demand to domestic demand and macroeconomic indicators will recover from 2022. But the recovery level depends on Covid-19 prevention and restoration of domestic market demand and conﬁdence.
- The annual GDP growth for 2023 is projected to be around 3.6%, 5.3% and 6.6% under the pessimistic, baseline and optimistic scenarios, respectively.
- 2023 will be the ﬁrst year of implementing strategic plans laid down by the 20th CPC National Congress.
- It is critical to ensure the continuity and stability of policies. Macro policies should endeavor to “stabilize growth, promote recovery, prevent risk and ensure safety” improve the conﬁdence and expectations of market entities and keep restoring and boosting the internal drives of economic growth.
A new world order: Farewell to the ‘Great Moderation’
- We’ve entered a new world order. This is the most fraught global environment since World War Two – a full break from the post-Cold War era.
- The four-decade period of largely stable activity and inﬂation is behind us. The new regime of greater macro and market volatility is playing out. A recession is foretold; central banks are on course to overtighten policy as they seek to tame inﬂation.
- Geopolitical cooperation and globalization are evolving into a fragmented world with competing blocs. That comes at the cost of economic efﬁciency.
- The new inﬂation regime requires more granular views by focusing on sectors, regions and sub-asset classes, rather than on broad exposures.
- Sourcing more locally may be costlier for ﬁrms, and we could also see fresh mismatches in supply and demand as resources are reallocated.
What will 2023 hold for investors?
- The US economy has remained resilient, despite high inﬂation and the rapid pace of rate hikes. Energy shortages have already taken a toll on growth in the Eurozone and the UK.
- Forecasts of a mild recession, but a regime change ahead for stocks and bonds, with both offering attractive opportunities.
- Inﬂation will continue to decline but remain above the low levels experienced since the global ﬁnancial crisis.
A mild recession, EU lagging behind
- A mild recession is expected, with regions such as the Eurozone
being more heavily impacted.
- As inﬂation subsides, the Fed will pivot from interest rate hikes to cuts and markets shifting focus to 2024 recovery.
- Markets in 2023 will lead the economic recovery for 2024, unlocking more potential opportunities for investors who are guided by relevant market precedents.
A bit of optimism
- Sub-potential growth (1.6%) globally will likely lead to higher unemployment rates. Inﬂation will remain higher than in the pre-pandemic years, but lower than in 2022.
- Financial market volatility will remain elevated as risks persist and global ﬁnancial conditions remain tight, creating continued headwinds to growth. Nevertheless, investors can ﬁnd opportunities.
Resilience versus recession
- In the US and Europe there’ll be weaker economic growth in 2023. Any recessions are likely to be short lived, but they will not be painless.
- The combination of lower growth, lingering inﬂation and public spending constraints will be difﬁcult for both people and governments. Social inequality will be a topic of immediate and growing importance.
- The worst should now be over: inﬂation will ease down (but stay well above central bank target levels). Major global setbacks (from geopolitics, disease or other factors) should be avoided.
Some progress in an uncertain world
- Global growth is expected to be just 1.8% in 2023, as US resilience contrasts with the Euro area and the UK likely mild recessions, mainly because of the real income hit from surging energy bills.
- There are concerns about political and geopolitical shocks, but some of these risks have diminished slightly: the Italian and US midterm elections have come and gone without major market disruptions. Spreads on Italian government debt have diminished, and the “lame-duck” session of Congress.
- The latest meeting between Presidents Biden and Xi promises to defuse at least some of the tensions between the US and China, which might also help to achieve a negotiated solution to the Russia-Ukraine war.
Next year will be a long, hard slog
- Global economic momentum continues to slow, with the Eurozone and UK in recession, US growth well below normal, and China’s 2023 recovery likely to be shallow.
- The lower-than-expected US inﬂation print for October, however, signals that we are getting closer to peak rates, even if we’re not quite there yet.
May we live in interesting times
- In the US, the economy experienced a strong second half of 2022. Jobs are being created in signiﬁcant numbers, wages continue to rise, and households keep spending. In the Eurozone, lower energy prices have temporarily stopped the downturn.
- Growth will be slower than in 2022, but the seeds of recovery could be planted in 2023, as inﬂation drops and reduces the drag this has on real spending power.
- 2023 is shaping up to be a year of turning points, as market rates peak out and drop, and curves re-steepen as future cuts are contemplated, especially in the US.
Risk of recession
- The risk of recession remains high due to the European energy crisis, monetary policy tightening, and China‘s difﬁculties in overcoming its housing crisis and former disengaging from its zero Covid policy.
- Inﬂation remains high in EU and the US, but the ﬁrst signs of slowing pressures on global supply chains are also appearing, foreshadowing lower prices for manufactured goods in 2023.
- In the US, stabilization of energy prices is expected to bring inﬂation down in 2023.
- The Italian environment appears favorable, in light of the stabilization of European core rates at higher levels and spreads that, although rising, remain far from worrying values.
A mild recession
- The core scenario sees developed markets falling into a mild recession in 2023 on the back of tighter ﬁnancial conditions, less supportive ﬁscal policy in the US, geopolitical uncertainties, and the loss of purchasing power for households.
- Despite remaining above central banks’ targets, inﬂation should start to moderate as the economy slows, the labor market weakens, supply chain pressures continue to ease, and Europe manages to diversify its energy supply.
‘Keep it Simple’ in 2023
- The long-term view is that we have entered a regime change that requires a different approach to overall global macro and asset allocation.
- US inﬂation has peaked. The recession fears we face in 2023 are likely less ominous and more in the price than the inﬂation fears that surprised markets in 2022.
- The top 25 global central banks boosting rates will fall to 12% in 2023, compared to fully 84% in 2022.
- For investors, it is the time to keep it simple and diversify across multiple asset classes ― not concentrate one’s portfolio the same way one would have during the 2010-2020 period.
The ﬁnancial markets
- The global economy appears to be entering a period of structurally higher inﬂation overall, associated with reconﬁguring supply chains – the on-shoring or ‘friends-shoring’ of production – and with the increased spending associated with climate change.
- After a 2022 marked by shocks, investors may be better prepared to approach the year ahead with an eye on differentiation when it comes to investing.
Applying the lessons of a turbulent year to 2023
- Rarely have investors had to grapple with the lessons imparted by a global economy emerging from a pandemic, while dealing with unprecedented monetary policy measures and a war in Europe.
- Monetary policy will be the key driver of asset prices in 2023.
- The Fed’s mission is to help lower inﬂation to its 2% to 2.5% target and keep it there, durably. With continuing improvements on the inﬂation front mixed in, there are the ingredients for a strong ﬁrst quarter.
- A conﬂuence of unprecedented events in 2022 weakened markets. Investing has come with its challenges and uncertainties due to slowing global growth, inﬂation and monetary tightening, China’s Covid restrictions and property slump, the Russia-Ukraine war, and an intensiﬁed US-China tech rivalry.
- The core scenario sees a mild recession in 2023 for developed economies, such as the Eurozone and UK; a recovery is expected toward the end of 2023. Social inequality will be a topic of importance.
- The key economic question for 2023 is whether central banks will be able to bring down inﬂation to more acceptable levels without a recession. There are reasons to be optimistic, but there are also substantial risks to this view – as the economy slows, the labor market weakens, supply chain pressures continue to ease, and Europe manages to diversify its energy supply. The market has yet to price this, which is why volatility will continue in the ﬁrst half of 2023.