2023 is set to be a year of “turning points” according to Swiss private bank Lombard Odier in its 1H2023 global investment and macroeconomic outlook that focuses on Asia and China’s reopening.
The Swiss private bank’s chief investment officer (CIO) Stephane Monier says the global economy will slow down initially in 2023 before recovering further in the year. Disinflation across key regions with diverging slowdown paths will have an impact on growth, but he says the downturn will set the stage for an eventual recovery this year as policy rates reach their peaks.
According to Monier, inflation has started its descent and the disinflationary trend will continue for the rest of 2023 — but central banks will remain restrictive for a while. He notes that inflation has peaked and is rolling over thanks to falling energy costs, while service inflation remains elevated and related to the strength of labour markets. “Central banks should stop hiking in 1Q2023 but refrain from cutting rates for an extended period of time to weaken employment further,” he says.
There has been a divergence between goods and services, with the disinflation of goods set to continue its downward trajectory, while Monier sees service inflation calming down “eventually”.
Annual consumer price inflation on a purchasing power parity basis in the developed markets of the US, the Euro area, the UK and Japan are expected to come down from their peak of 7.6% last year to 4.5% this year, while emerging markets will also see the same trend from 8.3% to 5.8% in 2023.
Monier is expecting to see US consumer inflation ending 2023 below 3%, falling “significantly” as the food and energy price shocks of 2022 and service prices stabilise. Overall, he sees inflation declining even with his 2023 average West Texas Intermediate (WTI) oil price assumption of US$90 ($119.43) per barrel.
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Meanwhile, he says that the labour market is still “too tight” for central banks’ comfort. While disinflation in the service sector requires more slack in the labour market, conditions remain tight. Monier notes that unemployment rates across key markets remain near historic lows, while wage growth remains high — although it has started to soften.
He believes that global monetary policy is approaching its peak policy rate and is in “restrictive territory”, and expects to see a slower pace of hiking — but not cuts — before an extended pause.
According to him, the upper band of Fed Funds rate (FFR) is expected to peak at 5%, while the European Central Bank deposit facility rate is expected to peak at 3%.
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Considering the benefits of a warm winter in Europe so far, Monier says the prospect of a full-blown energy crisis this winter has become less likely, adding that he sees little risk of energy shortages. European governments have taken measures to mitigate the impact on households and corporates, he adds.
With China making the “irreversible” decision towards a “living with the virus” strategy for its Covid-19 policies, Monier expects spiking cases and fatalities to create volatility in economic activities as consumers adjust to the novelty of a high infection environment.
Still, China’s sharp rebound is already in progress and he says Chinese activities will accelerate on a faster timeline than he initially expected, after the volatility in 1Q2023 from Covid-19 waves.
Monier explains that the Chinese government is already leaning on dovish monetary policy and industry deregulation to address downside risks from initial turmoil related to the rapid reopening process.
China’s rebound will be a “helpful boost” to emerging markets, with an outsized impact on exporters and tourist destinations in the Asia Pacific region, which he notes is far more exposed to Chinese demand than other regions.
‘Investment convictions’ for 2023
With monetary policy tightening in the West and a global downturn in economic activity, Monier says this makes for an unfavourable set up for risk assets. Macro conditions warrant cautious exposure to risk assets and as such, he suggests focusing on assets that can better withstand the impact of weaker growth or higher rates.
Given the recent peak in US 10-year real yields, he adds that sovereign and high quality corporate returns look promising this year. Monier prefers quality and diversification across asset classes, such as companies with the ability to defend margins and with exposure to China’s reopening.
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He sees earnings per share (EPS) estimates being revised downwards due to a squeeze on margins as inputs costs remain elevated and customers’ buying power reduces with inflation.
Meanwhile, expects emerging assets to rebound as emerging markets are boosted by China’s reopening. “However, a shift in sentiment and growth dynamics is needed”, he adds.
Given the current volatility levels and upcoming geopolitical concerts, Monier also recommends asymmetric return profiles, as global growth and real yield models turn for a weaker US dollar in 2023. A weaker US dollar, lower rates and China’s reopening could mean that gold’s appeal will also increase, and prices for the commodity should rise, he says.
Later in the year, as investor sentiment improves, he sees the appetite for risk assets increasing and high yield credit growing in attractiveness.
