Market Outlook 2023: The great interest rate reset
Growth and inflation will still be causes for concern next year; but markets are already showing signs of a comeback. We expect that confirmation of peak inflation in Q1 2023 may lead to a pause in interest rate hikes by central banks, which would set in motion the recovery process in fixed-income markets. The recovery of more cyclical assets, like equities, should get underway in H2 2023 if central banks announce lower interest rates. More than ever, it is paramount to balance a short and long-term vision when managing investments as investors should not ignore the need to be invested in real assets and in thematics related to innovation and sustainability.
What will 2023 bring?
Discover our key messages and possible investment strategies to follow
Key messages in detail
1. The great interest rate reset
A new policy regime after the shock. The sharp rebound in inflation is not only due to the Ukrainian invasion but is also the result of major structural changes in the economy (increased tightness in the labor market, energy transition, etc.) and in geopolitics (pause in globalization).
Markets will adjust to the new rate environment. Our base case envisages an adjustment process that would already be reaching its final phase from a monetary perspective. We believe that we are close to terminal policy rates and that the level of monetary tightening reflected in the curves will be enough to change the course of inflation.
2. The road to monetary stability
First signs of inflation peaking during Q1'23. When analyzing inflation dynamics and differentiating between its different components, we can observe two positive developments: decreasing tensions in prices of goods and anchored inflation expectations.
Value returns to fixed income markets. The resetting of monetary policy has been painful, but looking forward it provides bond investors with two positive benefits: increased diversification for portfolio construction and higher yields to maturity.
3. Vigilant on the cyclical pivot
Recessionary risks, but crisis unlikely. Monetary tightening, the higher cost of credit, the cost of living crisis and high uncertainty will undoubtedly dent growth in 2023. Economists’ consensus already assigns a high probability of GDP contraction in several countries.
Risk premia could still widen during downturn. Yields across asset classes have increased as investors have priced in a higher likelihood of a severe economic slowdown. In this report we analyze the adjustment in risk premia of cyclical assets.