By Generali Insurance Asset Management’s Macroeconomic Research Team
2022 saw geopolitics dominate attention, with events in Ukraine unsettling and resetting markets and the global economy. Meanwhile, investors also contended with eye-watering inflation, steep rate hikes and higher volatility across the board.
Will 2023 bring more of the same or are we seeing a fundamental shift in the macroeconomic picture? To answer this, we are pleased to present the latest views from the specialist asset management firms across the Generali Investments platform, as they look ahead to the risks and opportunities that 2023 may present.
In our view, 2023 will start in a stagflationary environment, with the major economies flirting with or heading towards a recession. The key questions lie in the depth and duration of the recession, as well as the pace of inflation deceleration. This very unusual environment creates high uncertainties, and room for twists and turns through the year. Five themes stand out, in our view.
1. Cracks in financial plumbing as monetary tightening proceeds
High inflation, an ensuing euro area recession and tighter financial conditions are exposing cracks in the financial plumbing. Bond volatility – even if past peak – remains high, the liquidity of even highly liquid assets such as US Treasuries has deteriorated while high quality collateral shortage has mounted, especially in Europe. Banks will suffer from rising provisioning needs. Fortunately, they are much better capitalized than going into the Great Financial Crisis and higher yields help. Yet larger vulnerabilities may be hidden in the non-banking sector. The sharp rise in UK yields in September exposed fragilities among LDI investors, and the FTX crash in the crypto sector, while emerging markets are exposed to ongoing US dollar strength. As central banks tap deeper into restrictive territory and the European Central Bank (ECB) joins the quantitative tightening wave, they will need to tread carefully to not unsettle markets.
2. When will central banks pivot?
Central banks are still showing their teeth, committed to tackling inflation with front-loaded tightening. The Federal Reserve and ECB are set to slow the pace of tightening in December. Yet an outright policy pivot still looks distant as they deem a moderate overtightening less risky than stopping hikes prematurely. Rates are unlikely to peak before late Q1 once central banks take note of sequential readings of slowing inflation, a cooling US labour market, receding inflation expectations and developing recession (mild in the US, more visible in the euro area). Risks of an earlier pivot mainly arise from financial market unrest.
3. Ukraine war and energy transition – short-term drag, but long-term accelerator
Europe is striving to replace disrupted gas and oil imports from Russia. It has restarted coal power plants, increased LNG imports and incentivized new gas exploration in Africa. This is a clear blow to GHG reduction targets in the short term and a major medium-term drag to euro area competitiveness and growth. Longer term the shock is set to accelerate the energy transition to nuclear and green alternatives. The need to curb exposure to future geopolitical shocks only adds to the case for diversifying and greening energy generation.
4. A reshaping of the world order
The Russian invasion of Ukraine and rising US-China tensions – not least over Taiwan – will have profound economic and business implications. With the risk of supply chain disruptions rising, countries and firms will reconsider the trade-off between efficiency and security. Re-shoring or “friendshoring” to political allies will thrive, potentially severing global trade ties into political blocks (democratic vs. autocratic). This will not only reshape capital flows but will require higher investment and may curb productivity. Increased military spending will add to energy costs, raising new debt sustainability and social stability challenges: a new impossible trinity?
5. China’s slow economic revival
China’s economy has suffered from its zero-Covid policy, an ailing property sector and a regulatory IT crackdown. Chinese authorities are signaling a cautious policy shift. Yet the pace will be slow. Low vaccination rates among the elderly renders a quick reopening risky. Eased regulation may temper acute strains in the property sector but will not reverse its need for a structural decline. Mounting rivalry with the US will accelerate China’s ambitions to be more independent in high-tech and financial services, but replicating knowledge and R&D will bear substantial transition costs. The economy is set to rebound from poor 2022 performance, yet faces a steep uphill battle.
