Awaiting market recovery signals
Indeed, 2022 has been an abnormal year. Rising inflation, a hawkish rate-hiking environment, and geopolitical tensions have triggered volatility and sharp adjustments across various asset classes. What’s more, major economies are on the verge of recession.
While it may be premature to predict an end to these market adjustments, our experts believe that the central bank easing cycles will begin in 2023. Furthermore, the US Federal Reserve (Fed) may increase its Fed Funds rate to a peak of almost 5% or above by the first half of 2023. The nuance would be whether it’s a pivot or a pause.
Will we see a central-bank pivot in the first half? While monetary easing by developed-market central banks may occur before the end of 2023 (as growth concerns overtake worries about the inflationary backdrop), the Fed and other central banks could pause and maintain rates at current levels before changing direction. Inflation will have to unwind to a point where most central banks could pause and assess the impact of—to borrow a phrase from the Fed—cumulative tightening before the end of 2Q 2023.
If more manageable inflation fails to materialise, central banks will then face two options: choose to look through inflation (e.g., inflation now is no longer the only considered by the Bank of Canada in its decision-making process) or continue tightening beyond what has already been priced in by the market. The second scenario would likely lead to another bout of heightened financial market volatility.
If that happens, global central banks will continue to fight inflation, be vigilant of peaking inflation, and retain their hawkish bias. In turn, this would lead to a stronger US dollar. In other words, the status quo of 2022 will remain – pro-dollar, elevated rates and equity-market volatility, as well as a higher-for-longer inflationary environment. Headline inflation will continue to drive market sentiment, and if price rises haven’t peaked, central banks will need to be more restrictive with their monetary policies.
In Asia, we see clear signs of economic re-opening amid increasing policy support from China. The broader Asian economy may benefit from a fuller economic reopening (for instance, mainland China, Hong Kong SAR, Japan, and Taiwan) and a recovery in tourism. South Asian economies are opening their borders amid higher vaccination rates. Notably, economies more exposed to declining global demand could be relatively worse off due to the looming slowdown or recession.
Developed-market central banks are expected to begin easing before the end of 2023, as growth concerns overtake worries about the inflationary backdrop. The Fed Funds Rate should peak at around 5% by the first half of 2023.
A return to pre-COVID growth rates. Our five-year forecasts show an eventual post-recession return to 2% growth (and inflation), with potentially material downside risks to growth. We also believe markets have failed to appreciate the growth drag created by the growing uncertainties surrounding endemic COVID.
Slightly higher inflation, but with a different composition. We expect longer-term inflation to climb from around 2% towards slightly above 2% in the United States, with similar adjustments on a global basis. However, its composition will change, becoming more global and supply-side in nature. This would make it more challenging for central banks to combat and, in our view, force policymakers to accept higher inflation. It could even induce incremental changes to their focuses and mandates.
No breakout from the long-term, lower-yield paradigm. While market rates appear to be breaking out from their 40-year downtrend, we believe the next few years will see a return to the low interest rate paradigm as potential growth rates, labour-force participation rates, and productivity remain muted, if not worse post-COVID than pre. Without a significant productivity shift, we do not believe that yields can break out of their multi-decade trend.
Deglobalisation trends, particularly China’s decoupling from the West, will encourage more investment in local supply chains and generate inflationary pressures. It is also likely to produce higher and more persistent geopolitical risks – recent legislation around microchips is an example of this trend.
An accelerated ESG focus will likely distort traditional macro signals and drive longer-term, longer-duration fiscal spending. Applying an ESG lens to standard investment calls will become increasingly necessary. We see the social/sustainability elements of ESG taking on much greater importance throughout 2022/23. Separately, it’s becoming increasingly difficult to discount climate events. While the precise nature can’t be modelled, their frequency makes it increasingly important to make allowances for associated distortions.
As we gain more clarity after drastic market adjustments, how should investors be positioned to capture growth and income opportunities? Given improving sentiment, investors might return to the market by reviewing and rebalancing their portfolios or capturing attractive entry points (after riding out the market bottoms). At Manulife Investment Management, we believe our solutions can help investors achieve natural yields, hedge inflation, and diversify their assets to capture market dislocations and opportunities.