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Macroeconomics: Patience will be required in 2023

‘A look ahead to 2023’ download our full report below

Global investment markets start the New Year at a pivotal stage within the economic cycle. Many economies are transitioning from slowdown towards inevitable recession.

We say ‘inevitable’ for two reasons: a historically swift rate of monetary policy tightening is a key actor underpinning this recession and a textbook countercyclical monetary policy response to deteriorating economic conditions is not on the cards. Central banks will not ride to the rescue as they attempt to head off escalating inflationary risks.

Through the latter half of 2022 investors have quite rightly been pre-occupied with the effects upon market levels from this central bank policy tightening phase. Now is the time to start thinking about when the light at the end of the tunnel comes into focus.

We think the following conditions will have to be met before we get constructive on risk.

1. It will need to be clear that inflation has peaked

We think that it will be in Q1 before there is substantial and clear evidence that core inflation has peaked sequentially in the US, the UK, and continental Europe. Thereafter, a downward trajectory can be sustained; base effects will be helpful and decreasing realised inflation should stabilise expectations. In saying this we are mindful of the tightness of the labour market and deteriorating productivity growth, which we think could keep inflation higher than it has been in past cycles.

There are structural shifts underway too, including de-globalisation, demographics, and the green energy transition, which will keep inflationary pressures more elevated than before.

Shweta Singh, Senior Economist

In Europe, the inflation dynamics present themselves augmented by higher energy prices due to the Russia-Ukraine war. But, absent a renewed energy shock, European inflation will also slow next year. Evidence of this improvement will come through a little later than will be seen in the US.

2. Central banks terminal rates will need to be established

We won’t have to wait until the last policy rate hike is actually put in place as long as expectations of where terminal rates lie and the duration for which they remain at those levels are properly discounted. Again, we think that this could be a Q1 event.

3. Earnings expectations should reflect recession risks

Earnings downgrades are underway, but the revisions do not yet reflect the sharp slowdown and decline in economic activity that we expect over the coming quarters. When falling inflation is established, the risks of a further increase in the discount rate is diminished, and earnings revisions are downgraded sufficiently, the stage may be set for stronger market performance from both equities and government bonds. The positive correlation between equity and bond markets – an effect that has been so damaging in 2022 – will stay in place but, this time, it can
be while both markets are generating positive returns.

Over the full year, 2023 promises to be a better year than 2022 proved to be. However, you might have to be patient at the start of the year. Crucially, with inflation remaining structurally higher than before, limiting monetary policy pivot and the growth rate staying below the potential rate of expansion, the room for sustained positive returns may be limited.

A look ahead to 2023

A year of reflection, consolidation and recasting strategies.

A look ahead to 2023

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