The global economy is bending, but not breaking.
The intensity of the recession following the pandemic has been matched by the demand recovery that subsequently ensued. It didn’t take long for economies to make up lost ground as the manufacturing sector sprung back to life and consumers jumped at opportunities to spend their recently accumulated savings on goods and services.
This combination of strong aggregate demand and constrained supply chains at a time of very simulative monetary and fiscal policy created the perfect conditions for economies to overheat. It can, as we are seeing currently, become a self-reinforcing wheel.
So, where are we now as we reach the end of 2022? Economies have overheated and have begun slowing down, with some potentially in recession already. Are we there yet? Will monetary tightening lead to a deep recession? We believe the answers lie in inflation dynamics. Download the full report for our outlook across asset classes.
What should investors expect in 2023?
No one who started investing over the last 30 years has seen meaningfully high inflation in the developed world. Today, however, inflation rates have been breaking into high single and even double digits, the result of a number of different drivers – some of which may be temporary but others potentially more persistent.
We believe inflation dynamics are about to improve as temporary drivers begin to lessen and permanent factors do not spiral out of control.
A continued slowing of the global economy looks likely. High inflation, particularly as energy costs reduces the real spending power of consumers, will exercise influence although, as previously noted, increases in energy costs in Europe are likely to be largely temporary in nature. Some economies are entering the year in worse shape than others with the UK already likely in a recession as a result of the energy price shock.
However, we believe, even as the global economy bends, it is unlikely to break.
Central banks are likely to keep hiking rates in the first half of 2023, but at a more moderate pace than we have seen over 2022. At some point in early to mid-2023, they will likely then pause. Monetary policy acts with a lag on growth, inflation and labor markets, so central banks will want to assess what impact past rate increases have had on the economy.
In our central case inflation levels out within 18-months, without causing a major recession.
High and sticky inflation that prompts further aggressive central bank actions is a key risk. As annual inflation rates fall in 2023, there is a risk they do not fall far enough and remain entrenched at higher rates than central bank policy makers would ideally like. There is also a risk that central banks have already tightened too much and with the long lags monetary policy has to take effect, economies are already heading for a deep recession.
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