The global economic paradigm is changing. After almost 15 years of record lows, interest rates are fast rising around the world and inflation is spiralling as concerns grow over the cost of living crisis. Added to this, the ongoing energy crisis and continued fears over deglobalisation are sewing further doubts about the outlook for 2023.
In the Schroders Crystal Ball 2023 Investment Outlook, Chief Economist, Keith Wade, Chief Investment Officer, Johanna Kyrklund, and Senior European Economist, Azad Zangana, discussed what these challenges will mean for investors over the coming year.
Keith Wade points out that they are forecasting a recession in the US and Europe for 2023. “We do expect that 2023 on a global basis will be the weakest year for global growth since the global financial crisis. So quite a significant slowdown in economic activity. Obviously, there’s been a lot of talk about the recession over the last few months and we do think that will come through. We think it will be quite a hard landing as well“, says.
However, the expert highlights that the benefit of the downturn in economic activity is that they do expect a turn in inflation and all forecasts at the moment are really critically dependent on what happens to inflation going forward. “We believe that the tightening of monetary policy will be sufficient to slow down demand in the world economy and that will weigh on prices and start to bring inflation down”, clarifies.
Global decentralization
There is a bit of a decentralization going on in the world economy at the moment: recession in the US and Europe, a stronger China, and emerging economies improving. According to Wade, the emerging market economies are expected to do a little bit better in 2023, and that is primarily being driven by China. “We believe that as we go through into 2023, we will see those lockdowns being progressively lifted. And we’re also seeing signs that the housing market in China is beginning to bottom out. So those two factors, we think will support activity in the Chinese economy in 2023. So for China, 2023 will be a stronger year than 2022. We think growth will be 5% next year compared to 3% this year.
There’s a bit more work to be done from the central banks
“We still think there’s a bit more work to be done from the central banks. We see two more rate rises from the Fed, for example. We think they’ll raise by 50 basis points next week and they’ll follow that up with a 25 basis point increase in February next year when they first meet in 2023. But thereafter I’ll prepare to be on hold”, points out Wade.
He explains they think that the Fed will be cutting interest rates. They believe that although inflation will probably be still quite high, they believe that a recession will cause the Fed to begin to ease. They expect unemployment to rise sharply, for example, in 2023, and they will respond to that. “They will recognize that they have done enough to bring inflation down on a sustainable basis”, says.
In the eurozone, there’s a bit of a lag there in that inflation takes longer to come down and that means that the ECB have more work to do. “We think they will raise rates to 3%, but then they will be on hold through 2023 and we won’t see rate cuts from them until 2024. And it’s a similar story in the UK. Rates will rise by more than in the eurozone. They will rise to 4% in our view, and then they will be on hold right through to 2024 when we start to see some easing as the benefits of the slowdown in the economy begin to be felt more on inflation”, explains.
How does the current scenario affect the markets?
The Chief Investment Officer, Johanna Kyrklund, gave his view on how this challenging scenario will affect the markets. “So the first question really is do we think that bonds now offer enough value? Now, one challenge we face is that compared to the last decade, which had very deflationary risks, bonds that offer the same diversification opportunities”, points out.
Looking ahead, Kyrklund explains they are expecting inflation to come down next year, but ultimately they do expect to be in a slightly more inflationary regime for years to come. “Investors will require more yield from bonds to compensate them for the fact that they’re not as diversifying as they used to be. Now, the good news is, after the very significant declines we’ve seen this year off quite a lot of value at this point in time”, adds.
The expert details that in their view you don’t often have to provide quite a cushion to bond markets. “Although we expect the Fed to raise rates further, the pace of those records is slowing, that momentum of rate hikes is slowing, and that in itself that relative stability compared to what we have had to deal with this year. Does it make it easier to take advantage of the heels on offer in fixed income? So all in all, in recent months, we have upgraded our view on fixed income markets. We have been taking advantage of spread of credit in credit and emerging market debt because we think that there is a significant cushion there off the declines of this year”, explains.
She also says that they believe we are currently transitioning into the slowdown phase where growth really starts to disappoint and they expect to be hitting a sort of recession signal in the second quarter of 2023. “That suggests consistent with what Keith was saying, that there’s a bit more work to do in terms of equity prices before we can turn bullish. But the important thing to remember is that equities move ahead of economies“, highlights.
“Actually, in some sense, the environment starts to improve for equities as you hit those recessions. So cautious for now based on the cyclical model, but certainly with the potential for opportunities towards the middle of 2023”, Kyrklund concludes.
