A Year of Inflections

We think that year-over-year rates of inflation have peaked in the United States and are in the process of peaking in Europe. In both regions, we expect inflation to decline through 2023, but the pace and magnitude of the path lower will contribute to volatility, reflecting investor fears that even higher interest rates may be needed for longer.

Although incoming data will be key, we expect the Federal Reserve, the European Central Bank, the Swiss National Bank, and the Bank of England to conduct their final rate hikes in the first quarter of 2023, or the second quarter at the latest. Dependent on how sticky inflation proves, the Fed could be in a position to cut interest rates by the end of the year.

As higher interest rates begin to affect the economy, we expect growth and earnings expectations to fall through the first half of the year. Overall, we are looking for a 4% earnings contraction in the US, a 10% decline in Europe, and 2% growth in Asia for the full year. But we expect global growth to trough in 2023, and growth forecasts should improve later in the year as investors begin to look forward to 2024.

China’s economic cycle has been distinct from the rest of the world’s, due to the country’s approach to managing COVID-19. Developments from here will hinge on policy decisions, and President Xi Jinping’s consolidation of power has added to investor unease. But the outlook could start to improve if a full reopening, which may be likely around the middle of the year, supports consumption, and if higher infrastructure spending helps offset weakness in the property sector.

Geopolitical events often spark volatility in financial markets but rarely change the broad trajectory of economic growth. Yet as we enter 2023, there is an elevated risk that politics could shape growth outcomes. Russia’s war in Ukraine poses energy and security threats to Europe and raises the risk of NATO involvement. US-China tensions are unlikely to lessen given Beijing’s increased focus on self-sufficiency, the Biden administration’s moves to restrict trade on security grounds, and the potential for discord over Taiwan. And, at an individual country level, the increased politicization of economic issues like inflation and interest rates broadens the scope for radical policy interventions and market dislocations.