Economy, ECB and Fed maneuvers on rates, inflation in 2023: Andrew Sheets, Chief global strategist di Morgan Stanley, presents his outlook for next year, also rattling off investment advice. Something already emerges from the title of his research: “Morgan Stanley’s 2023 Outlook: Growth Cools, Bonds Rule”. Will 2023 be the year of bonds?
Sheets begins by referring to the outlook that has been drawn up, regarding the economy of the whole world, by his colleague Seth Carpenter and the global economics analysis team of the American bank.
“Our team expects a context of weaker growth, lower inflation and the end of rate hikes“ by central banks.
“Ccome back weaker means continued deceleration of the global economy from 2022 until 2023. This slowdown will be triggered by several factors, including the slowdown in that post-Covid consumer demand which was excessive and the sharp increase in inventories in the retail sector. However, what will cause the weakening above all will be the delay with which monetary tightening will produce their effects. The last 12 months are the 12 months in which fed funds rates have been raised fastest in a year since 1981 and in which the ECB has launched monetary tightening at the record rate since the birth of the euro area”.
The strategist reminds that “the effect of rate hikes on the fundamentals of the economy takes a while to manifest” is that the “2023 will not do exception”.
Morgan Stanley: USA will avert recession, UK and euro area will not
Morgan Stanley’s outlook speaks of “United States that will prevent the recession for the skin of the cuff and of a recession that will instead hit the United Kingdom and the Eurozone”.
In the first case, the recession will be a consequence of a restrictive tax policy (after the crash that shocked markets around the world and brought down the government of Liz Truss). In the Eurozone, the recession will be caused by the great energy shock”.
As for China, “Growth will recover, hand in hand with our outlook, which will become more positive during the spring. However, the recovery will be weak, as the deleveraging process in the country’s real estate market will remain a challenge“.
All in all, “the slowest growth of the economy should (finally) cool down inflation. We understand the skepticism given the lingering surprises that have unfolded this year, but believe there are several forces that will change the narrative. That is to say:
- The weakest demand globally
- Less stress in supply chains
- The level of inventories is increasingly high, which will lead companies to apply discounts on goods considered essential
- The risks in the US housing market (a factor called shelter within the CPIs) will become more balanced.
- The base effects, i.e. the base effect, which will undergo a significant change. For example, US gasoline prices are up 11%Y but will be down 11%Y by March, at current prices”.
Morgan Stanley: US inflation will fall below Fed target
In this context Morgan Stanley also believes that not only will the Fed manage to hit its 2% inflation target but also that “US inflation measured by the CPI (consumer price index), currently 7.7%, will fall below the 2% threshold by the end of next year”.
Last Thursday the publication of the US CPI index for October highlighted a rise in inflation of 7.7% on an annual basis, from the previous rise of 8.2% in September and compared to the +8% expected by the consensus.
Investors immediately bet on the arrival of less aggressive tightening moves by Jerome Powell’s Fed in the mid-December meeting, after four consecutive hikes of 75 basis points since the beginning of the year.
Last November 2, the Fed raised rates by 75 basis points, taking them from the range between 3% and 3.25% to the new range between between 3.75% and 4%record value since 2008.
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Sheets continua:
“Slower growth and inflation should lead central banks to pause and assess the situation. Banks just raised rates significantly, and monetary tightening takes a considerable amount of time to work. With growth and inflation to slow, we believe che Fed will pause after raising rates, at the January meetingup to 4.625%”.
ECB and other central banks: the strategist’s view
Reference also to the ECB which, according to Morgan Stanley expert Andrew Sheets, “it will curb the tightening in March, at 2.50%”.
In this regard, it is worth remembering that, last Thursday 27 October 2022, the Governing Council of the Eurotower decided to raise of 75 basis points the three interest rates.
Interest rates on the main refinancing operations, the marginal lending facility and the deposit facility have been raised to 2.00%, 2.25% and 1.50% for accuracy. Rates were raised by the ECB for the third time in a row.
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As regards “emerging market central banks, which are well ahead of their advanced counterparts”, Andrew Sheets provides that institutions “they will roll out some significant accommodative maneuvers, especially in Hungary, Brazil and Chile”.
Right, “any outlook is uncertain, but that will be especially true this year. We see risks to downside growth, triggered by more persistent inflation that will trigger a more powerful response. We detect a significant uncertainty also regarding the QT (Quantitative Tightening); we believe central banks will show flexibility if systemic stress occurs, but both central banks and investors are navigating uncharted waters, regarding the reduction of balance sheets of such a magnitude (asset-inflated balance sheets after boom in asset purchases by central banks themselves).
What will happen to the markets? The winning assets will be…
According to Chief global strategist di Morgan Stanley,“pfor the markets, the context (next year) it will be very different (compared to the current one):
“If 2022 was characterized by resilient growth, high inflation and hawkish policy, 2023 will see weaker growth, to disinflation, the end of rate hikes or even the opposite (rate cuts in sight?). All this will take place in the face of very different starting evaluations. It seems reasonable to think that the outcomes will be different, especially in the case of bond high grade“.
“We believe 10-year US Treasury rates will end 2023 on the downside, which the US dollar will fall, that the S&P 500 will move cautiously (interspersed with significant fluctuations).
“We actually believe that i bond high gradeamong the assets that suffered the greatest losses in 2022, will be confirmed among the big winners of 2023. Real and nominal yields have grown significantly across a broad range of high-grade bond markets. Less growth, less inflation and less monetary tightening will make stable returns more attractive. Until the end of 2023, we therefore estimate attractive returns for Bunds, BTPs, European investment grade credit in euros, US Treasuries, investment grade credit in dollars, municipal bonds, mortgage backed securities (MBS) and securitized with AAA rating. And we are of the opinion – underlines the Morgan Stanley strategist again – that this theme of ‘income’ will become more extensive”.
In particular, “among our many recommendations it stands out the favorable view towards those segments of the market with higher returns, be it US equities (where we are overweight staples, healthcare and utilities) or commodities (where we prefer oil to metals). And if opting for income will be a key theme, ‘respecting the sequence’ will be another”.
That is to say?
“The markets will cope with two great unknowns, next year. Will inflation and rate hikes moderate, and growth bottom out? We expect more clarity on the first question than on the second. As a result, we generally prefer it assets more sensitive to interest rate uncertainty than those that are more sensitive to the growth of advanced countries”.
And so, concludes Sheets, such a scenario “should favor high grade bonds, which often perform better after the latest Fed tightening, whether followed by a recession. But the context should also be favorable for emerging market equities and debt. As the first assets to underperform (having peaked in 2021), emerging market equities should in our view be the first to recover and, as happened in early 2000 and 2008, 2022 has confirmed a historically negative year for cross asset returns. Next year won’t be easy, but it should be different“.