Economics & Growth | Equities | Global | Other | US
Buckle Up for a Challenging 2023
- By Richard Jones
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- 5 min read
Summary
- We review 2023 market outlooks from some of the world’s largest financial institutions.
- Investment banks and asset managers broadly contend that inflation has probably peaked or is near peaking.
- A global recession is likely in 2023, although many expect the US economy to fare better this year and avoid recession.
Market Implications
- The consensus is that bond markets will perform well in 2023 given this macro environment.
- Equity markets are viewed with much more caution.
- US dollar strength from 2021 and 2022 is expected to lose momentum and possibly reverse.
Introduction
It is that time of year again, with many of us having made new year’s resolutions in the past week or two. It is also the time when the big banking and investment houses publish their year-ahead outlooks. We have looked at a wide range of these publications to identify themes and synthesise what these themes mean for markets and the broader macro environment. The clear conclusion? We are in for a bumpy ride.
Has Inflation Peaked?
The pre-eminent driver for central bankers and markets in 2022 was inflation. Monetary policy tightened aggressively across the globe as it exploded higher last year, hitting 9.1% in the US and a blistering 10.6% in the euro area.
The consensus is that inflation will moderate in 2023, with almost all the outlooks saying that it is near its peak (with several saying it has already peaked). While this will be welcome news for central bankers and investors, some outlooks voice caution.
Blackrock, for example, expects inflation to cool into 2023 but sees it persisting above policy targets in the coming years. Similarly, Apollo Global Management says that although markets and central bankers will welcome the expected downtrend for inflation this year, it will probably take another two years before inflation returns to the Federal Reserve’s 2% target.
Is a Global Recession Inevitable?
The proverbial elephant in the global macro room is the idea of a worldwide recession in 2023 – is it inevitable
The intuition here is that with all the 2022 monetary policy tightening will come an economic slowdown. Perhaps the best description of these dynamics comes from Barclays, who published one of the more bearish outlook pieces. They wrote, ‘if 2022 was the year of policy shock and awe, 2023 will be the year of living with it.’
That said, while most of the banking and investment houses expect economic growth to slow considerably this year, some nuances are worth noting.
For example, Goldman Sachs expects the US to narrowly avoid recession. It also thinks the euro area and UK are probably already in recession. Wells Fargo Investment Institute says the US and global economies will face a moderate recession into mid-year, with a second-half recovery into next year.
On China, Goldman Sachs expect slow growth in H1, with an acceleration later this year, although they remain cautious longer term. BNP Paribas Asset Management believes the global economy verges recession as policy rates shoot higher, Europe faces an energy shock, and China struggles with zero-Covid policies and fragile property markets.
At Macro Hive, we see a US recession coming – but not before end-2023.
The Outlook for Bonds: Bullish
With an economic slowdown broadly expected to take hold in 2023, there is a noticeable positive consensus for the fixed income outlook. JP Morgan Asset Management said, ‘we are more excited about bonds than we have been in over a decade.’
Drilling down into the arguments for being long fixed income this year, there are various reasons for the broad bullishness.
Citi Global Wealth Management says the peak of the Fed hiking cycle may be coming into view. As such, they see opportunities to add short-term bonds, such as US Treasuries and investment-grade fixed income, to portfolios.
Similarly, UBS Asset Management notes that for the first time since 2007-08, investors now have attractive coupons across the entirety of the fixed income space. It also suggests yields are sufficiently high on short-maturity bonds that they can avoid taking a big bet on duration.
At Macro Hive, we like to underweight bonds. They have rallied lately and are now pricing rate cuts by the Fed later this year – that could be premature.
The Outlook for Equities: Bearish
While the optimism for fixed income is widespread, most of the outlooks were much more cautious on equities. They highlighted some opportunities, but the enthusiasm for equities is nowhere near that for bonds.
An important driver for caution towards equities is the potential for an economic hard landing, due to central bank vigilance on fighting inflation.
Fidelity International highlighted this as one reason for a selective approach to equity investing, with their prognosis favouring UK equities over European and US stocks. Generally, investors will need to be selective this year rather than relying on broad market gains, they added.
BNP also took a cautious tone, again highlighting potential geographic divergence. They think equities face a struggle to generate above-average returns, leaving them
neutral on the asset class, with deep caution in Europe offset by optimism for US growth stocks.
Morgan Stanley stood out with perhaps the most bullish outlook on stocks. Based partly on their view that the US economy will remain resilient, they point to the strong performance of economically cyclical stocks, such as financials, industrials and materials, in late 2022 as a harbinger of a strong 2023 for equities.
At Macro Hive, we remain underweight equities despite potential for near-term gains. We expect equities to remain in the trading range of the past six months until inflation is clearly on the wane – or the Fed takes further steps to slow the economy.
The Outlook for the US Dollar: Bearish
After an impressive rally in 2021 and 2022, the prognosis for the US dollar this year is less optimistic.
When discussing the dollar, most of the outlooks highlighted the importance of monetary policy and an aggressive Fed as a key pillar of support for the greenback in recent years. A common theme in the FX commentaries was that the end of the current Fed tightening cycle is approaching and that, as a result, dollar appreciation will lose momentum.
For HSBC, US monetary policy has been a substantial tailwind for the dollar, and that tailwind is fading fast. While the dollar might get some support from its status as a safe haven this year, HSBC has downgraded the dollar from bullish to neutral. They expect the Japanese yen to perform well in 2023.
It is a similar story at Credit Suisse. They expect the dollar to remain supported early in 2023 but stabilise and weaken later this year as US monetary policy becomes less aggressive. Like HSBC, Credit Suisse expects the yen to perform well, reversing early weakness later in the year as the Bank of Japan alters its monetary policy.
Deutsche Bank expects the US interest rate cycle to reach its peak in the spring of 2023, with the European Central Bank raising interest rates further. While they forecast little upside in the EUR/USD currency pair, Deutsche Bank sees scope for both the yen and the Swiss franc to strengthen this year.
At Macro Hive, we see scope for selling the dollar in the short term – partly on the China reopening theme, partly on the market’s perception that the Fed is turning less aggressive. However, we stress this is not necessarily a long-term trade given our belief that the Fed will ultimately get to 8%.
Conclusion
There is much common ground in the 2023 outlooks published by the big banking and investment houses, with nuanced divergence on how the global economy and markets will perform.
On inflation, there is broad consensus that we have either already seen (or are near) peak levels. A global recession is likely, partly owing to the aggressive monetary policy stance taken by central banks, although regional diversity can be expected, with some of the outlooks favouring the US economy over other regions.
For assets, there is widespread bullishness on bonds, with a much more caution towards equities. In both asset classes, regional diversity also features as a persistent theme. And, in the FX space, the US dollar’s strong performance is expected to moderate, likely reversing against some currencies as aggressive Fed monetary policy support comes to an end.