The global economy, plagued by gaps and uncertainties, is expected to grow at a meagre 2.1% this year according to Reuters, down markedly from the IMF’s 2.7% October 2022 forecast. Here’s a macro rundown of what’s happening where:
The global economy is currently facing a number of gaps and lags that are affecting growth and causing uncertainty. In the United States, while inflation data has improved, there is mounting evidence of a slowing economy. The U.S. Federal Reserve has signalled that it is likely to push their terminal rate – the peak of the hiking cycle of their key interest rate – above 5.0%, and hold rates steady until the end of this year. It stands currently at 4.5%, already 425 basis points higher than the 0.25% in March 2022 when the cycle began. Additionally, while the recession may be shallower than previously feared – indeed, market probabilities of a recession have moved progressively downwards over the last two months – they still imply shrinking activity and a fall in corporate earnings.
In currency markets, King Dollar may just start feeling some jitters to his throne. The trade-weighted dollar(DXY), although historically strong, may well weaken over the course of 2023, more in the second half of the year. The world’s most powerful currency has already peaked against major currencies as the Fed approaches its likely terminal rate and backs off from larger 75-basis point hikes. It still remains sky high and considerably ‘overvalued’. Those factors might augur a sharp tumble.
Figure 1: The trade-weighted U.S. Dollar index (DXY) is on a downtrend; Source:TradingView
In Europe, sentiment has been boosted by a fall in natural gas prices – along with the supply chain crisis, the main driver of decades-high inflation there – to levels not reached since Q3 2021, prospects for greater China demand, promises of potential EU measures to mimic the US’ industrial subsidies and a confident German Chancellor and French Finance Minister telling the Davos World Economic Forum meet that Germany and France will avoid recessions altogether. Even if some of the sudden optimism may turn out to be exaggerated, it certainly contrasts with increasing evidence of a slowing US economy, thus reversing the long-running Europe-doom versus US-boom narrative.
Figure 2: Natural Gas Futures are down to Q3 2021 levels; Source:TradingView
At the same time, following the rapid abandonment of its zero-COVID policy, China‘s leaders have been keen to boost optimism on the economic recovery with the Liu-Yellen meeting on the side-lines, raising hopes for reduced China-US tensions as well. Recent high-frequency economic data has come in better than expected, assuaging concerns of significant disruptions to the economy in the opening phase. Even if the true Q4 GDP was somewhat weaker than official statistics show, the recovery is underway, and the authorities see emerging markets highly motivated to support growth.
Japan, however, continues to boggle the mind. The world’s third-largest economy is expected to grow at a slower rate due to its ageing population and shrinking workforce, with the government’s focus on bringing down inflation from its current 4%-level to its 2% target. The potential for a trade war between the US and China may possibly further hinder economic growth, however.
For the Bank of Japan (BoJ) – which for the lack of a better phrase – doesn’t even have an interest rate since the advent of the era of Abenomics over the past decade (the key policy rate has been -0.1% since December 2015), yield targeting in the bond market becomes unequivocally crucial, and effectively, their only tool to control monetary policy. Having already raised the target yield for its 10-year benchmark bond by 50 basis points last year, all eyes are set to be on what they do next with their yield curve control (YCC) policy. Most economists expect the BoJ to abandon it by mid-year.
Figure 3: The Bank of Japan’s key policy rate has beennegative since December 2015;
A Europe that avoids a deeper energy crisis, coupled with a China recovery and a Fed that has done most of its tightening by now, is good news for the emerging market (EM) universe. With prospects for rising commodity demand and peaking US rates, capital flows have started to return into EM, as evidenced by high inflows into EM-dedicated funds recently.
There are reasons to be optimistic about India‘s economic outlook in 2023 – the World Bank expects it to be the fastest growing major economy, after all. While the private sector balance sheet has declined markedly under the current government regime, it has seen a slight uptrend in the last year or two. The government will be hoping to build on that, although the rate of growth of capital expenditure is expected to halve in the upcoming budget.
Figure 4: The Reserve Bank of India has been able to keep inflation within its target band with key interest rate hikes; Source:TradingView
Corporate deleveraging has also helped banks’ balance sheets, and high GST and direct tax collections have provided the government with the means to spend and cushion the impact of the impending global slowdown. Consumer demand among the affluent class remains strong, and recent labour market data suggests unemployment rate remains under control, marked by increased labour force participation and job creation in certain sectors as well. The three major headwinds to growth this year are likely to be a surprise spike in inflation, aggressive monetary policy tightening and a lack of further improvement in the labour market. The economy is expected to grow between around 6.7% in FY 2022-23 and 6.0% in FY 2023-24.
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