Financial contagion risks have added to the outlook uncertainty and are bound to make central bankers more careful. Taking a step back, we can conclude that true system resilience is still far away, despite the lessons we supposedly learned from past crises. And monetary addiction is still holding the system hostage.
Economic activity - Gradual investment-driven global slowdown
For now, we do not expect the recent banking sector stress to transform into a systemic crisis, as it appears that policymakers have reacted adequately to avoid further turbulence.
However, even without a banking crisis, the recent banking sector stress will likely accelerate the significant tightening of bank lending standards that was already set in motion before the stress emerged. This will continue to put downward pressure on the housing market and therefore hamper real estate investment. Business investment will also slow as the year proceeds, as the rapidly tightened credit conditions will significantly increase the (re)financing costs for corporates, impacting profitability and thereby putting the brakes on capital expenditure.
That said, our projections for developments in savings rates and real household disposable income imply a continued modest (and fading) support for growth coming from consumption in the next few quarters, certainly when the reopening of China is considered.
Combined, this means global economic activity is set for a gradual slowdown. Only slowly fading consumption strength and regional divergence mean a global recession will be avoided. But the effects of monetary tightening will become increasingly visible in business investment across the major advanced economies. In the US, we expect a contraction in business investment starting Q4, which should tip the US economy into a mild recession. We expect sluggish eurozone growth going forward, and an even more prolonged period of close to no growth in the UK. Japanese activity growth will slow going forward, while Chinese activity will remain firm in the first half of the year before normalising.
Inflation - What goes up must come down
We expect headline inflation to come down significantly across advanced economies as the year proceeds. This is predicated on our assumption that energy prices will remain broadly stable at current levels. Of course, robust household (services) spending makes it less likely for global core inflationary pressures to quickly abate. But since inflation expectations have remained anchored, we don’t expect a full-blown prolonged wage-price spiral. Nevertheless, current wage dynamics make it unlikely for headline inflation to decline to the 2% central bank target by year end.
Interest rates – Financial stability back on the table
The recent banking sector stress has brought financial stability concerns back on the table and has made our (until recently below-consensus) policy rate forecasts for both the Fed (5.00%-5.25%) and ECB (3.50%) more likely. Going forward, central bankers will have to face the policy trilemma of inflation, economic activity, and financial stability, in which we deem the latter to ultimately prove decisive for policy decisions. But we expect policy rates to be left untouched for the remainder of the year after central bankers have halted the hiking, because headline inflation will likely still be above 3% in the US, the eurozone and the UK by year end.
Allocation - Heightened uncertainty warrants a neutral stance
Going forward, deteriorating macroeconomic fundamentals should result in slowing corporate earnings growth. That said, we still believe that the rate hike pause of the major central banks and eventual forward guidance hinting at lower rates early in 2024 will overshadow the weakening fundamentals. But with uncertainty high, we deem it wise to stick to our neutral equity allocation stance for the time being.
We expect longer-term eurozone yields to gradually move somewhat lower in 2023, reflecting disappointing growth, the rate hike pause by the ECB and eventually a forward guidance towards rate cuts. Nevertheless, the heightened uncertainty and possibility for corporate financial difficulties further down the road, potentially triggering a rise in downgrades, makes us cautious when it comes to bonds. We therefore maintain our neutral allocation stance and prefer high quality names.