We expect inflation to moderate and central banks to pause tightening in the first half of 2023, which should help take the global economy from the current contraction to a recovery regime and set the stage for the next market cycle.
In 2022, central banks across the globe raised interest rates with “a degree of synchronicity not seen over the past five decades," the World Bank warned in September. Will they ease off the gas in 2023? That depends largely on the path of inflation going forward. Our annual outlook addresses the breadth of possibilities that lie ahead in the new year.
Inflation: The critical question for investors
Chief Global Market Strategist Kristina Hooper summarizes our expectations for 2023, including the view that inflation should moderate and central banks should pause tightening in the first half of the new year. She also presents an alternative scenario in which persistent inflation extends the current period of contraction.
Kristina (00:05):
Hi, I'm Kristina Hooper, Chief Global Market strategist at Invesco, and I'm delighted to bring you our 2023 investment outlook. Back in September, the World Bank warned that central banks around the world have been raising interest rates this year with a degree of synchronicity not seen over the past five decades, which has increased the risks facing the global economy. The outlook for the global economy is largely dependent on central bank actions, and the path of monetary policy going forward is very reliant on the path of inflation going forward. So to address the breadth of possibilities that lie ahead in this environment, we have provided a base case scenario which we believe is highly probable, as well as an alternate scenario that we believe is less likely.
(00:56):
So let me start with the base case. We believe we're currently in the contraction phase of the economic cycle with global growth below trend and decelerating, which we expect will continue in the near term. We think the contraction globally will be a modest soft patch, although some economies will be hit harder than others. So as 2023 begins, we would favor a defensive position tactically. Now we expect inflation to moderate and central banks to pause tightening in the first half of 2023. The market is likely to begin to anticipate this in advance of an actual pause, which would mean the economic recovery would start to be priced in. We expect the economic recovery to unfold later in the year, where global growth will be below trend, but rising.
(01:48):
In our alternate scenario, inflation remains stubbornly high, forcing central banks to continue tightening monetary policy for longer. In our view, this would maintain the contraction regime for longer than we anticipate in our base case. We would expect this to increase the probability of a global recession, resulting in worse growth and further pain in risk assets. Thank you for listening. For further details, including our detailed asset allocation views, please download our complete Invesco 2023 Investment Outlook.
Our base case anticipates that a pause in central bank tightening in the first half should help usher in an economic recovery. We also consider an alternate scenario in which central banks find themselves battling stubbornly high inflation, increasing the probability of a global recession.
Following the extraordinary loosening of monetary and fiscal policies across the world in 2020 and 2021, inflation has become broad-based and significantly above target in most economies, leading to aggressive central bank tightening. The major outliers are China (where policy is loosening), and Japan.
Note: Number of central banks among 38 leading central banks. The number of central banks hiking or cutting rates is measured on a one-month rolling basis. Source: Macrobond and Bank for International Settlements, Sept. 30, 2022.
An alternate possibility we have considered is that inflation could persist higher for longer, requiring central banks to be hawkish for longer than we expect in our base case. We would expect this to increase the probability of a global recession, resulting in worse growth and further pain in risk assets.
Note: Chart shows market inflation expectations derived from the difference between nominal and inflation-protected government bond yields for relatively liquid short- to medium-term bonds. Sources: Bloomberg and Invesco, as of Nov. 4, 2022.
Following on from Kristina's comments about the global outlook, Global Head of Asset Allocation Research Paul Jackson focuses on the issues that could differentiate the European region in 2023.
Inflation: The critical question for investors
Paul Jackson (00:10):
Hello, my name is Paul Jackson. I'm the Global Head of Asset Allocation Research at Invesco. Following on from Kristina's comments about the global outlook, I want to focus on the issues that could differentiate the European region in 2023. We believe the European economy is at greater risk of recession than the US for a number of reasons. First, Europe is suffering more pain as a result of the sanctions imposed on Russia and Belarus, and the reduced economic activity in Ukraine. In fact, exports to those three countries in 2020 accounted for 0.8% of the European Union's GDP versus only 0.03% for the United States.
(01:05):
Secondly, 22.5% of Europe's primary energy was sourced from Russia in 2020, which renders Europe susceptible to a sudden cut in supply and necessitates a transition away from that source of energy. On the other hand, the US is effectively energy self-sufficient. Thirdly, the rise in gas prices has been more severe in Europe, leading to higher inflation and a bigger squeeze on real incomes. The one obvious offset to all of this has been the decline in the euro and sterling versus the dollar, which should help Europe's net export performance. Despite higher inflation in Europe, both the European Central Bank and the Bank of England lag the Fed when it comes to policy tightening. However, market pricing suggests the belief they will tighten more aggressively than the Fed over the next 12 months, which, if it were to happen, could deepen the European recession.
(02:18):
From an asset performance perspective, we anticipate that the greater risk of recession in Europe will favour European defensive assets more than those of the US. We also suspect that the transition to outperformance by riskier assets may take longer in Europe. A scenario under which global inflation remains more persistent than in the base case would prolong the negative performance of most assets with central banks pushing interest rates and bond yields higher while deepening and prolonging recession in Europe. This would reinforce our preference for defensive assets in Europe. On the other hand, we believe that a scenario in which global inflation falls more rapidly than in the base case would bring particular relief to European risk assets as it would reduce the squeeze on real incomes while allowing the Bank of England and the European Central Bank to end their rate hikes sooner and lower than expected. For more information, please consult the full outlook document on the Invesco website.
Our base case calls for the global economy to move from the current contraction to a recovery regime. Below, we show which assets we would favor in each regime.
A collection of charts that illustrate the details of our base case and alternate scenarios.
Alternatives investment outlook: What's trending in alternatives in 2023
In our assessment of the alternatives investment universe, we offer insight to areas of opportunity in private markets in 2023 and share asset class specific views.
Fixed income 2024 investment outlook
As we head into 2024, the market consensus is generally that interest rates have peaked – which is exciting news for bond investors. We explore the implications across a broad range of fixed income asset classes.
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.
The opinions referenced above are those of the author as of 30.11.2021.
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