Our core scenario looks for global growth to moderate and inflation to cool, albeit to still above-target levels over the next 6-12 months. Yet, as we laid out in the opening section, it’s more important than ever to consider the risks to our central view given elevated levels of uncertainty. Below we describe a range of scenarios for the economy and markets that we view as plausible over the coming year.
Cooling growth, cooling but above target inflation
Growth slows significantly in developed markets, but any downturn is short and shallow. Fiscal stimulus helps to offset real wage pressures in Europe. Policy support helps to stabilise China’s economy as Covid restrictions gradually ease. Inflation persists above central bank targets, but with economic activity cooling and headline inflation rates trending down from high levels. Interest rates rise more gradually than current market expectations, easing market fears of a central bank-induced recession.
Equity markets stabilise despite earnings downgrades. Growth stock valuations face further headwinds. Long-term bond yields edge gradually higher, with credit outperforming core government bonds.
Developed market economies slow sharply as price pressures overwhelm the consumer. Covid concerns and lockdowns are extended in China. Negative demand shocks eventually lead to falling energy prices, helping to bring inflation back down but at the expense of a significant hit to growth. Unemployment rises as business confidence slumps and cooling wage growth eases inflationary pressures further. Central banks pause tightening plans given slowing inflation and in order to prioritise the growth outlook.
Equity markets decline, but the central bank pivot provides some offset. Government bonds outperform both credit and equity as sovereign yields decline. Growth stock underperformance slows given lower bond yields.
Slowing demand fails to bring inflation down as energy supply scarcity drives prices higher. Wage costs eat into corporate margins as spiralling prices cause workers to persistently demand higher pay. Despite slowing growth, central banks are forced to tighten aggressively, given fears of inflation expectations de-anchoring, causing a deep recession.
Worst case scenario for equity markets. Bond yields move higher with curves flattening as central banks are forced to hike more than current market expectations. Government bonds outperform equities, but all major asset classes deliver negative returns. Value outperforms growth given substantial pressure on equity multiples and elevated commodity prices.
A faster than expected reopening in China leads to easing supply chain bottlenecks. Despite the associated boost to demand, commodity prices remain anchored, potentially on the back of a de-escalation of the war in Ukraine. As a result, inflation falls back more quickly than currently anticipated. A degree of resilience in labour markets supports real wage growth as broad inflationary pressures ease. Central banks move ahead gradually with tightening plans without materially slowing growth.
Best case scenario for equity markets, with strong earnings growth being delivered. Value outperforms, but with rotation from energy to financials. Equities outperform credit, and credit outperforms government bonds as spreads narrow.
Past performance and forecasts are not reliable indicators of current and future results.