Global slowdown to subdue inflation
- Both Europe and the US are forecast to fall into recessions. Inflation should ease over the coming two years as global growth slows
- Equities have ample space to rebound, although many headwinds remain. We expect ‘defensive’ and ‘quality’ stocks to perform better in the first half of 2023, followed by ‘cyclical’ and ‘growth’ shares in the second half
- Fixed income investors stand to benefit most when inflation and interest rates peak – yields are higher relative to recent years, providing more potential opportunities
Following a highly challenging year, our expectation for 2023 and 2024 is to finally see inflation retreat against a backdrop of global growth slowing to its softest – barring the pandemic – since 2009.
We also anticipate recessions in Europe and the US, alongside a lacklustre recovery in China, before a slow recovery emerges in 2024.
However, expectations have been dashed in recent years – by the pandemic in 2020 and outbreak of the Ukraine war in 2021. As such, we cautiously consider our forecasts for the coming two years.
Looking to the year ahead, AXA Group Chief Economist, and Head of AXA IM Research, Gilles Moëc said: “2022 ushered in a new monetary policy era. We are in a configuration we have not seen for decades: A policy-engineered slowdown in the world economy. The intensity and duration of this tightening phase depends on the speed of disinflation in the US economy.
“While we are confident that by the middle of 2023 the world economy will start improving again, we would warn against any excessive enthusiasm. Beyond the cyclical recovery, many structural questions will remain unanswered.”
Asset class overview
There is plenty of room for equities to rebound in 2023 although many headwinds remain. Central bank tightening will continue to affect equity markets both in terms of levels and direction. Corporate earnings held up well in 2022 but we do not expect such resistance against the macro backdrop to continue. We expect ‘defensive’ and ‘quality’ stocks to perform better in the first half of 2023 and ‘cyclical’ and ‘growth’ stocks to benefit from the potential rebound in the second half of the year.
Fixed income markets have been in a state of transition - moving from a backdrop of low interest rates and low volatility to record levels of inflation and aggressive interest rate hiking. Credit spreads have widened but remained resilient despite an extraordinary rise in interest rates, an inflation shock, and rising recession risks – reflecting healthy balance sheets. Overall, European credit is currently cheaper than US credit.
AXA IM CIO, Core Investments, and Chair of the AXA IM Investment Institute, Chris Iggo added: “There were few places to hide in 2022. The backdrop ultimately forced a revaluation of fixed income and equity assets. However fixed income investors stand to benefit most from the peak in inflation and policy rates, as the trade-off between return and risk has improved. Yields are higher – compared to recent years – providing potentially better income opportunities while high yield markets also look in better shape than they have been for some time.
“Equity markets are vulnerable to the expected earnings recession. While energy firms have outperformed, the long-term outlook is challenged by the energy transition. We believe a new corporate investment cycle will benefit technology and automation-related companies.
“Regionally, European markets are well placed to benefit should there be positive developments in Ukraine. Asia will benefit from a post-‘Zero-COVID’ recovery in China. Long term, the US valuation premium is not likely to be challenged given the dominance of US technology, a greater level of energy security and more positive demographics.”
Below we outline our summary outlooks for key countries and regions in 2023 and into 2024
The US economy looks like it’s heading for recession in early 2023, although we expect it will be mild. The weaker economic backdrop will likely alleviate some inflation pressures. We forecast that inflation will fall sharply, albeit a little slower than consensus, while our GDP outlook is for -0.2% growth in 2023 and 0.9% in 2024, lower than the consensus. We expect the Federal Reserve to ease the pace of monetary policy tightening in 2023 with interest rates peaking at 4.75%-5%, though labour market developments – rather than inflation – will be critical. We see the Fed cutting rates in 2024.
The uncertain macroeconomic environment, energy crisis and tighter monetary policy is likely to push the Eurozone into recession. We expect the bloc’s GDP will contract by 1% between the fourth quarter (Q4) 2022 and Q1 2023, followed by a weak recovery. We expect inflation to peak at 10.8% in Q4 2022, receding to reach 2.5% at the end of 2023, but a tight labour market implies persistent inflationary pressures. We see the European Central Bank’s key deposit rate peaking at 2.5% in March - below the market expectation of 2.9% in mid-2023.
China’s economic outlook is dependent on how it exits its ‘zero-COVID’ policy and reopens its economy. We expect Beijing will pave the way for an economic reopening but that the path will be bumpy. With recessions likely in many developed economies, we forecast that falling exports will add to the motivations for continued policy accommodation, even if economic difficulties are somewhat alleviated by improvements to the struggling property market. We expect GDP growth for 2023 at an above-consensus 5% followed by a slight moderation to 4.8% in 2024 as the economy reverts to trend.
We expect the UK economy to enter recession in late 2022 and that GDP growth will average 4.3% in 2022, followed by -0.7% in 2023 and 0.8% in 2024. Inflation should begin to gradually retrace in 2023, before falling back towards the Bank of England’s 2% target in 2024. Interest rates are likely to peak at 4.25% in Q1 2023, but we expect to see loosening from Q4 and across 2024 to end the year at 3%. The precise timing is likely to depend on the scale of labour market adjustment. Political developments remain important, particularly the Northern Ireland Protocol negotiations.
Japan’s economy looks set to remain robust, with growth supported by the reopening of the economy with a subsequent recovery in tourism. We forecast GDP growth of 1.6%, 1.7% and 1.3% in 2022, 2023 and 2024 respectively. Inflation is set to remain above the Bank of Japan’s 2% target in the near term, with a weak yen adding to inflationary pressures. We anticipate that interest rates will remain on hold in 2023. However, the appointment of a new central bank Governor in April could signal a shift in approach.
Canada looks like it will be in the enviable position of avoiding recession, but it still faces several challenges, and we expect GDP to stagnate to around mid-2023. Overall, economic growth looks set to slow to a below-consensus 0.3% in 2023 and 1.1% in 2024. But inflation should fall to an average of 4.3% next year and 2.4% in 2024 - from 6.8% in 2022. The Bank of Canada has slowed its tightening, and we expect interest rates to peak at 4.25% in January; monetary policy will then likely be kept on hold through 2023 before rate cuts to 3.25% by end-2024.
Domestic and external headwinds will trigger a marked slowdown. We expect GDP growth in emerging markets (excluding China) to decelerate sharply in Q4 2022 and Q1 2023, then slowly improve in the second half of the year. Emerging Asia will suffer from weakening exports, and we expect most central banks in the region to pause tightening from March, due to falling inflation and weaker growth. Meanwhile in Latin America policy uncertainty after recent elections could dampen investor sentiment.
There is no doubt 2022 was a difficult year for investors across all asset classes, but as the year comes to a close, markets have found a more stable footing. While we do not expect the modest recovery towards the end of 2022 to indicate markets will revisit the valuation peaks of recent years, expectations for returns are potentially more positive.
We believe the current environment requires thoughtful investment strategies and with macroeconomic uncertainty still running relatively high, a level of defensiveness – and preparation for periods of volatility – may be appropriate.