Our core scenario sees developed markets falling into a mild recession in 2023 on the back of tighter financial conditions, less supportive fiscal policy in the US, geopolitical uncertainties and the loss of purchasing power for households. Despite remaining above central banks’ targets, inflation should start to moderate as the economy slows, the labour market weakens, supply chain pressures continue to ease and Europe manages to diversify its energy supply. However, we remain in an unusual environment, and it’s as important as ever to keep an eye on the risks to our central view, as they are skewed to the downside.
Persistent inflation, deep recession
Inflationary pressures increase as geopolitical tensions spike.
The hit to both business confidence and profitability leads to layoffs, driving unemployment materially higher.
Social unrest – given ongoing cost of living pressures –keeps wage growth high, but declining real incomes still hit consumption.
Monetary: Central banks are forced to tighten policy more than in our central scenario to anchor inflation expectations, even as growth deteriorates.
Fiscal: Higher borrowing costs constrain any ability to ease fiscal policy.
Fixed income: Stagflationary pressures limit government bonds’ ability to diversify equity losses. Credit spreads widen, with riskier sectors hit hardest.
Equities: Worst scenario for equity markets with earnings hit hard. Quality and defensives outperform.
Currencies: Safe-haven flows boost the US dollar.
Alternatives: Real assets provide some inflation protection. Hedge funds benefit from higher volatility.
Moderating inflation, mild recession
Developed markets fall into a mild recession and inflation moderates as the labour market weakens modestly and supply chain pressures continue to ease.
A deep recession is avoided. The housing market cools although this is unlikely to look like 2008.
Geopolitical tensions remain elevated but do not escalate and economic sanctions are kept in place.
Monetary: The Federal Reserve increases rates to around 5% and stops there. The European Central Bank stops hiking at around 3%. For the Bank of England, we see a peak UK interest rate of around 4.5%.
Fiscal: Divided Congress limits fiscal stimulus in the US. Continued disbursement of the recovery fund and energy support packages cushion activity in Europe.
Fixed income: Government bonds deliver positive returns. Investment grade credit outperforms government bonds.
Equities: Positive returns from stocks. Value outperforms but to a lesser extent than in 2022.
Currencies: The US dollar remains well supported.
Alternatives: Real assets provide income and some inflation protection. Hedge funds also provide diversification.
Inflation fades, growth recovers
Inflation cools quickly as geopolitical tensions ease. Energy and food prices retreat as the Russia-Ukraine situation improves.
Capital spending (capex) rebounds with confidence restored, helping economic growth to recover.
Unemployment rates remain low.
Monetary: Central banks stop hiking rates sooner and at lower levels than in the central scenario.
Fiscal: Stabilising debt service costs ease concerns around fiscal headroom.
Fixed income: Government bonds deliver positive returns, but riskier fixed income sectors strongly outperform.
Equities: Strong returns across equity markets, with cyclical regions and sectors outperforming.
Currencies: The US dollar weakens as growth broadens by geography.
Alternatives: Particularly strong environment for private equity and private credit.
Maria Paola Toschi
Maria Paola Toschi