02 January 2023
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Recession fears and fate of inflation set tone for 2023

Another exogenous shock could also threaten durability of economies.

By Edward Bell

As the global economy opens 2023, several substantial macroeconomic questions will shape the narrative of analysis this year. First off, have central bankers done enough to get inflation under control in major economies? Across the US, Eurozone and UK, policy rates rose by 1000bps in 2022 along with considerable tightening from economies like Canada, Australia and incipient signs of tightening from laggards like Japan and Switzerland. Inflation on a headline basis does look as though it has peaked in many markets: US CPI inflation has eased from more than 9% in the middle of 2022 and is expected to have moved below 7% for December. However, inflation remains above target in all economies with inflation-targeting policies and central bankers may continue to creep rates higher to put the post-pandemic inflation surge back in the box.

Secondly, 2023 will be a test of whether major economies can avoid recession. In part prompted by tighter central bank policies but also the impact of high costs on consumers, there was a notable downswing in activity in the second half of 2022 with the global composite PMI holding below the 50 threshold delineating expansion and contraction from August onward. If a recession does take hold in the US for instance, the follow-on question will be how bad and how long will it be? More recent datapoints are showing that economies are avoiding a cascade of gloom—composite PMIs for the Eurozone in December remained below 50 but have been on an upward trend—while the reopening of China as it moves away from its stringent Zero-Covid policy will be a welcome boost to growth, eventually.

Finally, policymakers will be attuned to the risk of another exogenous shock. After the pandemic of 2020 and Russia’s invasion of Ukraine in 2022, the durability of the global economy, financial markets and government response mechanisms appears strained. Another outside risk, particularly if it affects costs for basic materials, could pose major challenges for economies with limited capacity to respond.

The outlook for the GCC in 2023 remains constructive. GDP growth will slow sharply as the 16% increase in oil and gas output that we saw this year is unlikely to be repeated, and further production cuts from OPEC+ pose a downside risk to growth in this sector. Non-oil GDP is also expected to slow somewhat but is likely to remain relatively robust as governments continue to invest in strategic sectors and projects to diversify their economies. Our baseline forecast is for oil prices to remain above USD 100/b next year, which will allow governments to maintain spending even as private investment slows.

Today’s Economic Data and Events

  • 09:00 IN manufacturing PMI Dec
  • 11:00 TU manufacturing PMI Dec
  • 13:00 EC manufacturing PMI (f) Dec: forecast 47.8

Fixed Income

  • Fixed income markets endured a dreadful year in 2022 as central bankers aligned on a hawkish stance to combat inflation. The Bloomberg UST index dropped 12.5% last year as yields surged on the back of 425bps of hikes from the Federal Reserve. US Treasuries did show some signs of improvement in the last months of the year but not enough to compensate for heavy selling pressure earlier in 2022. With the Fed set to persist in hiking to at least 5% in the Fed funds rate, the near-term outlook for USTs appears to be still weighted to the downside.
  • The selling in US Treasuries was matched, and beaten, by European bonds as the European Central Bank made a major about-face and ended its long-running negative interest rate policy. A broad index of European debt, including markets outside the eurozone, fell by almost 19% in 2022 with some specific markets like the UK enduring substantial volatility as the government there chopped and changed on its fiscal policy stance.
  • High-yield and emerging market bonds also fared poorly as there was a general sinking in risk assets. An index of UAE dollar-denominated debt also had a tough year even as the dynamics of the domestic economy appear strong.
  • Minutes from the December meeting of the FOMC will be the central bank highlight to start the year.

FX

  • The US dollar was the standout performer in currency markets in 2022, rising against all peers as a combination of haven seeking and tightening from the Federal Reserve increased demand for the greenback. The broad DXY index added 8% last year though did start to fade some of its gains in Q4. Nevertheless, the dollar remains strong against most peers.
  • The Euro dropped almost 6% last year, moving below parity over several weeks and ended the year at 1.0705. Tighter policy from the ECB should help to bring some selling pressure to an end though the risks to the Eurozone economy still appear acute. The pound endured substantial volatility, hitting an all time low in late September upon the release of the loose budget from then prime minister Liz Truss and her cabinet. GBPUSD ended the year at 1.2083, down almost 11%.
  • The yen though was the worst performer among majors, with USDJPY rising by nearly 14% over the course of the year as the Bank of Japan’s near total reluctance to tighten policy by any means weighed on the yen. In the final weeks of 2022, though, the yen recovered some strength as the BoJ hiked its yield curve target, helping to bring USDJPY to 131.12 by the close of the year.
  • We expect more modest appreciation of peer currencies against the dollar over the stretch of 2023 although none of them would hit levels we would describe as ‘strong’.

Equities

  • Most global equity indices closed notably lower last year as investors reevaluated risk and money became more expensive. Growth stocks, especially those in the technology space, lost their lustre, and in the US the tech-heavy NASDAQ ended the year down 33.1%. The blue chip Dow Jones was somewhat less affected but that still closed down 8.8% while the broad S&P 500 lost 19.4%.
  • In Europe, the composite STOXX 600 ended the year down 12.9% with Germany’s DAX dropping by 12.4%. A bright spot in Europe was the UK’s FTSE 100 which managed to end the year up 0.9%. This was bolstered by multinationals listed on the index given the weak performance of the pound, however, rather than a strong performance from the UK economy; the smaller cap FTSE 250 ended the year down 19.7%.
  • Some of the best performing equity markets were closer to home. In India, the Sensex closed up 4.4% and the Nifty 4.3%, bolstered by comparatively easy fiscal and monetary policy.
  • Locally, the DFM added 4.4% while the ADX ended the year up 20.3%, with both indices benefitffing from the robust economic environment and a deepening of capital markets with a number of high profile IPOs this year. In Saudi Arabia, the Tadawul closed down 7.1%.

Commodities

  • Oil prices ended 2022 higher though the level of gains appears relatively muted given the risks at play in commodity markets. Brent futures closed 2022 at USD 85.91/b, a 10% gain y/y but considerably below their peak of nearly USD 140/b hit in March when markets were rocked by Russia’s invasion of Ukraine and its potential to upend global energy markets. WTI futures also managed a year/year gain of about 7%, closing the year above USD 80/b.
  • The reopening of China’s economy will be a fundamental force in the ebbs and flows for energy markets this year, particularly if there is strong demand for international travel from Chinese consumers. Russia will face more disruption to its energy markets as another EU embargo comes into effect in Q1, this time on refined products and markets will continue to adjust to the effects of the price cap on Russian oil.
  • Gold prices closed the year positively as it looks as though the Fed and markets are aligning on an eventual peak in rates. But the gains in the final weeks of 2022 only managed to offset heavy selling earlier in the year with gold prices of USD 1,824/troy oz representing a flat close year/year.

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Written By

Edward Bell Acting Group Head of Research and Chief Economist


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