Everything everywhere all at once

  • Negative confidence effects from the near-death experience in the US banking sector and the unresolved energy situation in Europe will shape the rest of the year. We maintain our call for a sizable recession in the US at the end of the year due to a slowdown in housing, manufacturing and construction, while economic momentum stalls in the Eurozone as fiscal stimulus is gradually pared back. The outlook for the Chinese economy has improved, but global spillovers from the reopening are limited. We expect global growth to slow to +2.2% in 2023, and to recover very modestly to +2.3% in 2024. Barring the US, Germany, Italy and UK, other large advanced economies will manage to avoid recessions but emerging markets, and commodity importers in particular, will generally remain under pressure due to rising internal and external imbalances. Low demand will keep the manufacturing sector in recession in 2023 due to consumers’ deteriorating purchasing power and a longer replacement cycle of durable goods. At the same time, oversupply is likely to persist well into this year, deflating the cost of traded goods. In this context, delivery times are normalizing and shipping costs are also nearing their pre-pandemic levels. Global trade in goods and services is likely to grow by only +0.9% in volume terms in 2023 (down from +3.7% in 2022) and to contract by -0.3% in value terms (down from +9.6% in 2022).
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  • Central banks remain ever more caught between a rock and a hard place: financial stability concerns could complicate the already difficult trade-off between managing sticky core inflation and maintaining growth in setting policy rates over the next few months. Resolving this dilemma could prolong the fight against inflation unless slowing demand is sufficiently disinflationary to allow central banks to tread more carefully. We expect inflation to noticeably decelerate over the coming quarters and average 6.6% at the global level this year before receding to 4.0% in 2024. Given sticky core inflation, we expect central banks to take a more measured approach to further rate hikes, striking a balance between maintaining a restrictive monetary stance and acknowledging growing vulnerabilities in the financial sector, especially if an inverted yield curve is tacitly accepted to allow banks to better manage down their rising duration gaps.
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  • Restoring confidence in the financial system and persistent energy uncertainty could delay fiscal adjustment this year to give more flexibility to monetary policy. After most countries have taken bold steps to cushion the impact of the energy crisis, fiscal space is now much more constrained amid rising interest rates. However, concerns about financial stability might require governments to prioritize bolstering the safety net, including by providing public debt guarantees and backstops to crisis resolution mechanisms and raising the coverage of deposit insurance. While such fiscal support could help central banks keep interest rates high to stymie inflation without being constrained by banking sector vulnerabilities, rising interest-rate burdens challenge debt sustainability. In particular, diminishing fiscal space could require difficult policy trade-offs as governments also tackle important structural challenges outside the current energy and banking crisis, such as the green transition of their economies and the launch of bold pension reforms, such as in France and Spain.
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  • The evolving banking sector turmoil will shape the capital markets outlook. While potential contagion effects of bank failures in the US and the rescue of Credit Suisse have been averted, possible dislocations could arise from considerable vulnerabilities to unrealized losses from a deeper correction in real estate and the re-pricing of private debt exposures. More critically, financing conditions are bound to tighten further as banks raise lending standards and safeguard their capital and liquidity buffers, further retrenching credit, with potential spillover effects for market liquidity. Given the current uncertainty about the central banks’ policy rate path, the first half of 2023 will most likely follow the current volatile market dynamics. Despite expected economic and policy tailwinds towards the end of the year, the rebounding momentum will be delayed into 2024. In this environment, we expect the long-end of the sovereign curves to range trade for the remainder of the year around current values, with some upside risks in the short-run and some downside in the second half of the year. Equities are very likely to finish the year on a mildly positive note, while the jury is still out on corporate credit, with credit risk making a comeback in 2023, especially in lower-rated buckets.
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  • What could go wrong? While the financial sector has not reached full-blown crisis mode, further bank failures and capital market disruptions cannot be ruled out as policymakers struggle to restore investor confidence. In Europe, more energy-supply constraints, for instance as a result of colder weather towards the end of the year, could require gas rationing, which would push 2023 GDP growth into negative territory; this scenario could be further exacerbated if the war in Ukraine escalates. In addition, higher-for-longer inflation increases the risk of a policy mistake by central banks, especially in the US, whose data-driven approach underestimates the lagged impact of rate hikes on aggregate demand and risks of a deeper and prolonged economic downturn. On the other hand, avoiding further dislocations in the financial sector by shoring up public confidence would boost investment and growth while allowing central banks to effectively manage inflationary pressures. In addition, a ceasefire in the war in Ukraine could release some market pressure and supply constraints, while China’s reopening could revitalize slowing global trade and accelerate the decline of producer prices. Last, geo-economic confrontations, sanctions, trade wars and investment screening in the name of national security pose risks to economies worldwide, with unintended widespread spillover effects.
Ludovic Subran
Allianz SE