December 16, 2022 | 13:03
Global Outlook 2023: Some Like It Cold
Four-decade high inflation, and the aggressive central bank response to it, was the dominant economic story this year. But spare a thought for the growth backdrop, which will help inform where inflation is headed next. And, there, a curious thing is happening as we approach the end of a tumultuous 2022—growth estimates for the year are being steadily upgraded in many key economies. In fact, when the dust settles, it now looks like global real GDP growth will be quite close to its longer-term average at just over 3% for the year. While down from last year’s crackling 6% rebound (after the 3% COVID dive in 2020), that’s still about half a point better than expected around the middle of this year, with upgrades to economies as diverse as the U.S., Britain, the Euro Area and, yes, Russia. A bit overshadowed by the series of 50 bp rate hikes by many major central banks this week was the fact that both the ECB and the Fed revised up their views on this year’s growth rate for their respective economies.
Yet, even with this mildly more upbeat outcome, 2022 still must be regarded as a disappointment, especially when compared with the growth expectations at the start of the year. At that point, prospects of a more complete reopening in tourism, travel and entertainment pointed to another rollicking comeback in global activity. Well, we did get the reopening—perhaps highlighted by the full and raucous crowds at this month’s World Cup in Qatar—and services spending did rebound. However, growth was clipped by the rolling lockdowns in China, the war in Ukraine, the widespread surge in inflation and interest rates, and worker shortages in many service industries.
Of course, above and beyond a soggier-than-expected growth outcome in much of the world was a brutal year for financial markets. The reset on interest rates turned the former “rally in everything” into pretty much “sell everything”, with negative double-digit returns in both equities and bonds, as well as deep pullbacks in real estate, crypto and even metals. To give a sense of just how tough the markets were, there has not been any year in the past 50 when both the S&P 500 and 10-year Treasuries had negative total returns in the same year, let alone double-digit drops. A fourth-quarter rally in both will dull the full-year pain—at their current 3.5% yield, 10s are down roughly 75 bps from the October peak. Still, after this week’s tough message from the FOMC, the S&P 500 is down almost 20% from the peak it reached on the very first trading day of 2022.
The combination of this year’s weak equity markets and a deeply inverted yield curve is certainly sending an ominous message for next year’s growth outlook. In staggering contrast to a year ago, the consensus is almost uniformly downbeat on the growth outlook for the coming year. It’s almost conventional wisdom that the North American and European economies will deal with a recession in 2023, of the mild or shallow variety in the former, and possibly a much more serious version in the latter. We do not quarrel with the consensus on this call, with no growth expected in the U.S., Canada, and the Euro Area, and an outright decline in Britain, cutting global growth to around 2¼%. In the post-war era, there have only been three other episodes when the Fed has tightened by 400 bps or more in the space of a year, and the U.S. economy was mired in a full-on recession within a year each and every time. This week’s hike brought the cumulative increase to 425 bps, and they aren’t done yet. If that weight of history isn’t daunting enough, the leading indicator has dropped eight consecutive months, and is consistent with at least a shallow downturn.
However, this cycle is like no other before it, and there are some special factors which will cushion the blow from the aggressive central bank rate hikes. First, household and business balance sheets remain generally healthy, highlighted by the persistence of pandemic savings. Second, there is still some pent-up demand for items that were unattainable in the past three years—vehicles, travel, Taylor Swift tickets. Third, there is still a deep well of demand for workers in some sectors, notably hospitality, construction and health care. Partly due to the latter factor, but also due to demographics (the so-called grey wave), we expect a much milder back-up in jobless rates than in a normal recession—rising to around 5% in the U.S. by end-2023 from 3.7% now.
Sorting through these various factors, there is still a reasonable chance that the North American economy can navigate the challenging waters without veering into an outright downturn. If energy prices continue to simmer down, if the supply chain pressures relent further, and inflation recedes faster than expected, central banks could ease off on the brakes relatively soon. We would place about 25%-to-30% odds on such a soft landing. Unfortunately, there is also plenty of risk that things could turn out much worse than our call, with geopolitical risks looming large and the ever-present threat of a spike in energy and/or food prices leading to even more aggressive rate hikes. We would assign roughly 20%-to-25% odds to a very hard landing. Our forecast assumptions of a shallow downturn thread the middle ground, with roughly a 50% probability.
The world’s second-largest economy will again go against the global grain in 2023. We look for the reopening and mildly looser fiscal and monetary policies to modestly boost growth in China to around 4.5% next year from the sluggish 3.0% clip in 2022. While some are even more upbeat, on the prospect of a rebound in domestic spending, we expect the much chillier external landscape to keep a lid on the recovery. This week saw industrial production cool to just 2.2% y⁄y in November, while exports fell a heavy 8.7% y⁄y in US$ terms. However, China also sports the lowest inflation rate among large economies at under 2%, offering it the leeway to ease policy and support growth. And domestic spending could use some support, as retail sales sagged 5.9% y⁄y last month, while the real estate sector’s struggles continue unabated.
An anticipated mild revival in activity in China provides a nuanced outlook for commodity markets in 2023 and will somewhat offset weakness in much of the rest of the world. While energy prices spent much of the past six months climbing down the mountain, some metals prices were going the other way, with copper prices bouncing 15% from its summer lows. The U.S. dollar is expected to lose some further altitude next year, which will also provide a backstop for commodity prices in an otherwise challenging environment. On balance, we are cautiously constructive on commodities, with oil and gas prices expected to be only moderately below this year’s lofty averages in 2023.
For Canada, firm resource prices and a competitive exchange rate, as well as still-plentiful excess savings will soften the blow from the rapid run-up in borrowing costs. Similar to the U.S., the Bank of Canada’s 400 bp cumulative rate increase has rarely been matched in the post-war era, although the mid-1990s saw such a move without a recession. (Wild swings in Canadian interest rates in the prior 20 years had apparently inured the domestic economy to such shocks.) In addition, much to the chagrin of many economists, fiscal policy is generally supporting growth, with almost all provinces doling out cheques. And, strong population growth of 1.5% or more will flatter consumer spending figures.
Still, the heavy weight of Canada’s large housing sector and its outsized consumer debt will offset those relative positives. Even with the steep correction of the past year, which has seen home sales plunge almost 40% and prices drop by double-digits, residential investment still accounts for nearly 7% of Canadian GDP versus little more than 3% stateside. And homebuilding has barely even begun to respond to the steep reversal in the resale market, with starts (at 265,000 this year) barely below last year’s lofty 271,000. Meantime, the roughly 40% of the population that carries the bulk of household debt (a record-high 182% of disposable income) will face increasing strain as mortgages steadily come up for renewal. As a result, we look for Canadian growth to chill rapidly in the coming year, slipping from this year’s solid 3.5% advance (we had expected 4.0% a year ago) to zero growth in 2023, with the probability of a few negative quarters interspersed.
Wrapping up, the only reason why we are even talking about a recession is because of raging inflation and the harsh medicine required to quell it. Monetary policy ultimately always works, and this is clearly a policy-induced slowdown. The best news for the economy and financial markets would be if that policy works fairly quickly and inflation recedes faster than expected, which would significantly raise the odds of our more benign scenario—and we should have a good read on that front by the spring. Fundamentally, we remain a bit more concerned than the consensus on the stickiness of underlying inflation and would thus characterize our North American 2023 forecast as a wee bit below consensus on growth, and above consensus on inflation.