Investors can expect “some light after the storm” in 2023, however inflation, geopolitical uncertainty and intensifying economic divergences will still be the main themes.
My expectation for 2023 is for a recession in the US and other leading economies, primarily because central banks will need to continue to raise rates to help quell inflation. In the United States, that would likely entail inflation falling but remaining above 3% and short-term interest rates landing around 4%—no soft landing, but no stagflation either.
We will likely see more market volatility in the months ahead. Markets want to believe that central banks will blink and change direction, negotiating the economy towards a soft landing. But in my view, a hard landing remains the most likely outcome for the US in 2023. The previous norm of central bank “whatever it takes” intervention during the financial crisis and the pandemic is going or has gone.
Until markets absorb this fully, we could see sharp rallies on the back of expected action by the Fed, only for them to reverse when it doesn’t materialise in the way they expect. Rates should eventually plateau, but if inflation remains sticky above 2%, they are unlikely to reduce quickly even if banks take other measures to maintain liquidity and manage increasingly challenging debt piles.
A key factor to watch is where the US dollar goes. If the Fed continues to raise rates, an even stronger dollar could accelerate the onset of recession elsewhere. Conversely, a marked change in the dollar’s direction, potentially as its relative strength and confidence in monetary and fiscal policy making become an issue, could bring broad relief, and increase overall liquidity across challenged economies.
Other parts of the world are on different trajectories. Japan has so far maintained looser policy settings; but any shift away from its current yield curve control could lead to unintended consequences for the yen and potentially add another layer of risk to the already elevated levels of volatility in foreign exchange (FX) markets.
“In Australia, the RBA is nearing the end of its tightening cycle after cementing its position as one of the most dovish central banks in the developed world”
China too has taken a different pathway in 2022, thanks to its zero-COVID policy and the reining in of its property market. In the next 12 months, we expect policymakers to continue to focus on reviving the economy, investing in longer-term areas such as green technologies and infrastructure. Any loosening of COVID restrictions will cause consumption to pick up. The deglobalisation that has arisen from the pandemic and tensions with the US will take time to work its way through but is a theme that will grow.
In Australia, the RBA is nearing the end of its tightening cycle after cementing its position as one of the most dovish central banks in the developed world. It pivoted to smaller quarter percentage-point hikes in October and gave itself maximum flexibility to manoeuvre by saying future moves will be data-dependent. Economists are predicting two more quarter-point steps in 2023 to take the cash rate to 3.6%.
Despite the challenging environment, there are reasons for some optimism. China has begun to re-open, with the largest beneficiaries from reopening within the services sector given China is the largest consumer of Australian tourism and education exports, and Australia’s official interest rates may not reach predicted levels (even if they do, they are still low by historical standards).
We think the companies that will do well in this environment are those with a strong competitive advantage and structural growth. These companies tend to have higher operating margins which can help insulate against rising input costs, along with an ability to pass higher costs on to customers.
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