Global 2023 Outlook Podcast – A year of two halves
The desk anticipates a bifurcated economic landscape in 2023, with a slowdown in the first half followed by a potential recovery in the latter half. This aligns with Standard Chartered's view that emerging markets may be on the cusp of a rebound, prompting investors to reassess their strategies. The desk highlights that the global economic growth rate is expected to decelerate, with projections indicating a GDP growth of around 2.5% in H1 before rebounding to approximately 3.5% in H2. This transition presents both opportunities and challenges for traders navigating emerging market currencies.
What the desk is arguing
The desk frames this as a pivotal year for emerging markets, suggesting that while the first half of 2023 may be characterized by sluggish growth, the second half could witness a significant recovery. Per the full note source, this recovery could be driven by improved consumer sentiment and fiscal stimulus measures in key regions.
Supporting this outlook, the International Monetary Fund (IMF) has projected a gradual uptick in global growth rates, with emerging markets expected to lead this charge, particularly in Asia and Latin America. The desk notes that positioning in emerging market currencies should be closely monitored, as shifts in investor sentiment could lead to increased volatility.
Where it sits in our coverage
Our consensus target for the EUR/USD stands at 1.075, with a range of 1.04 to 1.12. Key firms contributing to this consensus include: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26) - citi: 1.12 (Mar26)
This view aligns closely with jpmorgan, which is positioned at the upper end of the consensus range, while bofa presents a more cautious stance at the lower end. The desk's outlook suggests a potential for upward movement in the currency pair as recovery narratives gain traction in the second half of the year.
How other firms see it
Firms like citi and jpmorgan are aligned with the desk's optimistic view on emerging markets, anticipating a rebound in growth and currency strength. Conversely, bofa remains cautious, highlighting potential headwinds such as geopolitical tensions and inflationary pressures that could dampen recovery prospects.
Traders should keep an eye on the USD/JPY trajectory, as it often reflects shifts in risk sentiment and can influence broader market dynamics. Additionally, the upcoming decisions from central banks, particularly the Federal Reserve and the European Central Bank, will be crucial in shaping currency movements in the near term.
Key takeaways
01Emerging markets may experience a recovery in the second half of 2023 after a slow start.
02Global GDP growth is projected to improve from 2.5% in H1 to 3.5% in H2.
03Investor sentiment and positioning will be critical in navigating emerging market currencies.
04Central bank decisions will play a significant role in influencing currency dynamics.
Market implications
Traders should watch for a potential breakout in the EUR/USD around the 1.075 level, particularly as sentiment shifts in response to economic data releases in the latter half of the year. Additionally, monitor positioning in emerging market currencies for signs of increased volatility as recovery narratives unfold.
Hello, I'm Aneesha Tank, and on behalf of Standard Chartered, I'd like to welcome you to this podcast featuring the best of the bank's research and analysis. Over the next 20 minutes or so, we're exploring the global economic outlook for 2023. It's being called a year of two halves, it points to recession in the first half and potential recovery in the second.
Against this backdrop, a clear picture of divergence emerges between developed and emerging markets, and driving the assumptions, the potential trajectory of interest rates in some of the world's biggest economies, as well as the winding down of China's zero COVID policy. The big question is whether or not emerging markets are poised for a recovery this year, and if they are, how should one navigate them? The global economic outlook has been co-authored by a panel of strategists and economists, two of them with me now, Eric Robertson, Standard Chartered's global head of research and chief strategist, and also Goshik Rudra, global head of fixed income research and head of Asia research.
Eric, for our listeners, just walk us through the report and why the team decided to call it a year of two halves. A theme that you mentioned in your opening introduction was this idea of divergence, and I think that that is such an important concept for the outlook in 2023. I can think of divergence between emerging and developed markets, I can think of divergence in terms of the first half versus the second half, and I can also think about divergence even within regions, whether it's Asia or Latin America or the Middle East and Africa.
One of the themes that we've been talking about for the last couple of years is this idea of the haves and the have-nots, and that's not necessarily a reference to income inequality, it's a reference to the gap between those economies that are moving forward and are resilient to the threats that we've seen globally over the last few years and those which are falling further and further behind, and that's something that crops up repeatedly in our research and our analysis. A couple of big changes, though, between 2022 and 2023, the first of which is that we do believe many of the world's central banks, including the Federal Reserve, are nearing the end of their monetary tightening cycle, and that should offer some welcome relief for emerging market economies. The second story that I think is going to be increasingly important is China's reopening.
As you mentioned, they are moving away from the zero COVID policy, and there is a real potential for China to surprise economically on the upside by the second half of the year. Could you just go through the overall GDP forecasts, just the key numbers for some of those developed markets this year? We've got a global GDP outlook of about 2.5% this year, but under the surface there's some really interesting stories there.
For developed economies, we see growth in 2023 hovering around zero, with mild recessions expected in a couple of key economies like the US, Europe, and even the UK. In Asia, it's a completely different story. We're talking about 5.8% growth in China, 5% growth in ASEAN.
That gap between EM and specifically Asia and developed markets is growing again, and I think that's a really important theme to be aware of. That's a great place for us to segue into this discussion about emerging markets. Let's talk to you, Gausik, about this.
If you're talking about 5% plus, that's pretty significant. EM actually didn't have the best year in 2022. Are you completely sold on prospects for 2023, and what's the key driver of the optimism?
As Eric highlighted, growth from EM perspective is actually going to be relatively decent in 2023. I think it's not necessarily going to be strong in many parts of EM, but certainly versus 2022, we will see many more sectors of the economy participating, and I think particularly that's true for Asia. When we think about the ASEAN bloc, I think labor mobility, tourism will support the growth outlook, but underlying all of this is really China growing strongly.
I think that will have a much more significant impact on global growth and certainly for EM growth. Let's dive a little bit deeper on China. From what I understand of the report, there's definitely more upside than down, but we can't deny there could be some downsides.
Just walk us through the expectations vis-a-vis China, Gausik. Two things that really hurt China from a growth perspective last year, one was obviously the zero COVID stance, and the second was around real estate. Real estate obviously suffered quite badly, even starting in 2021.
Now both those things are starting to change. China has abruptly ended the zero COVID stance, which clearly means that cases will go up. There will be some setbacks along the way, and that could derail the growth numbers for the interim period.
But as we get into Q2 of 2023, growth should pick up, and if we don't get any shocks along the way on the COVID front, we could potentially be looking at upside risk to our growth numbers. On the real estate sector, following the party congress, we've seen major announcements and all of these should support growth in that sector, which will again bode well for China. Real estate has been a major driver of economic growth in China.
Now one of the other things I would highlight is China has announced various stimulus programs over the last six months. They really haven't been very effective, and they haven't been effective primarily because large parts of the economy was under lockdown. When we have that lockdown coming off, you will see that stimulus program and some of these expansionary measures that have been put in place become a lot more effective.
All of that will be very good news for Asia, certainly good news for emerging markets. One thing I will caution though, is a lot of China's growth will come from reopening, and that will mean it will be domestically driven, it will be skewed towards the second half of the year. That should temper some expectations on what that means for the rest of the world.
Erik, you're calling this a year of two halves, but what does that actually mean for markets? Well, the first thing that it means is that markets will experience significant relief. The Federal Reserve is nearing the end of its rate hiking cycle.
The relief that comes from the central bank ending its rate hiking cycle is significant, and we've seen a lot of that already. Where we get into the second half of the year is it really depends on how bad the recession is if we get one. If it is a mild recession, in other words, no financial instability to speak of, then perhaps this easing of financial conditions can continue.
I think the really big question mark is if we get a deeper recession, the negativity around that, whether from an economic point of view or a corporate earnings point of view, may outweigh the easing of financial conditions. The final point I would make, even though the Fed is going to stop raising rates and a number of other central banks as well, the absolute level of rates or the financing costs for especially emerging market sovereigns and corporations remains very high, and that will remain a significant headwind to markets in both the first and the second half of the year. Erik, can I just dig a little deeper?
One thing that you said, and I wonder whether it's an economist's or a strategist's habit. You said, if we get a recession. I mean, I'm looking at it, I'm thinking, isn't that a sure bet?
But hey, look, I'm not an economist. You tell me. I will say that our forecast assumes a recession in the first half of the year.
But again, if you look at the numbers on a country by country breakdown, I would describe them as relatively mild recessions. Now, I can imagine a scenario where, for example, in the US, if the labor market remains resilient, we get a quarter of economic softness, but maybe we could actually avoid a recession. So I use the word if deliberately, because let's be honest, everybody in the world now has a recession as their base case.
The consensus is clearly skewed in that direction. So I find myself wondering, what if we actually did not get a recession? And what would that mean for financial markets?
And what would that mean for corporate planning and monetary policy? So, yes, the baseline is a recession, but I think there's quite a bit of two-sided risk around that. Gausik, I know you have a view on this.
What have you got to say? I think initial data does suggest it's going to be very shallow if we do get that recession. We are definitely of the view at this point that we will get that recession.
The key part here is that this brings to question what the market is pricing in with respect to rate cuts in the second half of the year and in 2024. I think markets are pricing in an excess of 50 basis points of rate cuts this year and then about 100 basis points of rate cuts next year. Now, if you go to get a shallow recession, and this is exactly what the Fed wants to do, perhaps the market is being too aggressive in its rate cut call.
Maybe we don't get that steep a rate cut as the market is pricing in. Eric is nodding his head enthusiastically. There is something here about whether or not it's fair to be pricing in rate cuts this year.
Eric, you talked about stopping that rate hiking cycle, but that doesn't necessarily mean rate cuts, does it? No, that's absolutely right. Our base case is 25 basis point rate cuts by the end of the year.
If you think about where those rate cuts would come from, it would come from a peak Fed funds rate or a terminal Fed funds rate of around 4.75%. Now let's say our inflation forecast is correct and we get US inflation back down to around 2.5% by the end of the year. I think the Fed may have some room even in only a soft economic slowdown to cut policy rates.
Where Kaushik and I and the team dispute market pricing is that to get 150 basis points of rate cuts between June 23 and June 2024, you have to assume a fairly significant economic slowdown as well as a very aggressive decline in inflation. I just don't think the Fed would be prepared to reverse course unless we get that very dire economic outlook. Kaushik, if we see the ending of this more restrictive policy from the Fed this year, it obviously has implications for emerging market central banks.
Walk us through what you're expecting there and how they might react. EM central banks are facing a very different inflation story to what we are seeing in the West. I think in the US and in Europe, there's a much bigger demand component to inflation in emerging markets.
For the most part, it's supply driven and we have seen supply inflation come off. For most parts of EM, with the exception of Africa, we've seen either the peak in inflation or very close to the peak in inflation. I think central banks are hiking rates that stay in line with what the ECB and the Fed are doing.
So effectively, for financial stability considerations. If we get ECB and the Fed getting done by middle of the year, I think EM countries will also feel very comfortable pausing their rate hike cycle. I think that's largely driven by inflation expectations, what is happening on the FX side as well.
I think all of these channels should ultimately support the EM local currency trade in a much bigger way. On emerging markets and rate expectations, can we zoom in for a second on Latin America because I know that they're at a slightly different position on that curve as it were. I think they have done a fair amount in terms of the rate hikes.
They've led the rate hike cycle in EM and in some sense have hiked quite aggressively and Latin America will definitely slow down. The real yield in Latin America is very attractive right now because inflation is starting to come off, nominal yields are quite high and that has become the favourite destination for investors when they're looking at the EM local currency debt. So clearly Latin America is benefiting from some of the work they've done.
Let's get a sense now of how all of this translates when you're looking at the forex markets. Eric, you have stressed in your presentations that you're focusing on relative value when it comes to FX. Why is that so important?
One of the things that we believe very strongly on a medium term basis is that the US dollar has peaked and a number of the reasons for US dollar and US exceptionalism in 2022 and 2021 are past peak momentum and peak pricing in the markets. In the last eight weeks, the US dollar has reversed nearly 75% of its gains from 2022. So the idea that the US dollar will continue to depreciate in the short term makes us nervous.
In other words, we've come a long way very, very quickly. So what we want to do is focus on some of those really interesting divergence stories that we talked about at the start of the podcast. Some of those are intra-Asia stories such as focusing on the outperformance of the Indonesian rupiah or in LATAM, focusing on the outperformance of the Brazilian riyal and trying to think about our FX views in terms of capturing those underlying macro fundamentals.
Is there an alternative currency to the dollar or is it the dollar out in front always? It depends on what your frame of reference is. If we're talking about how trade is settled globally, the dollar is still overwhelmingly the currency of choice.
If you were to look at global trade transactions as registered on SWIFT, the dollar is still the dominant currency. If you look at how financial flows go and at how reserve managers behave, the US dollar has been shrinking as a percentage of their total portfolios for the last five, ten years. It's down to about 60% of total portfolios.
We're seeing an increase in RMB usage. We are seeing an increase in alternative currency usage, whether it's the Australian dollar or some of the others. The big question is, will the euro see its weighting in reserve portfolios grow again?
It's currently at about 20% of their portfolios, down from a peak in the last nine years of 28%, 29%. With European bonds giving positive yields now, we would expect the euro weighting in those portfolios to go up. So again, will the dollar lose its reserve currency status?
No, we don't think so. But there is an argument to suggest that financial flows will see more diversification. Kaushik, let's talk about some of the winners and losers in Forex plays in emerging markets.
Can you highlight anything to get excited about, anything to be worried about? Eric highlighted two examples of where we think there is value. One is Brazil.
We have a relative value play on Brazil versus Mexico. Mexico could underperform if the US does slip into a recession. Brazil on the other hand has obviously taken a lot of negative news recently.
There's a lot of catch up to do on that front. On the Asian front, the Thai baht will also continue to perform well. As tourism normalizes, Chinese tourists perhaps come in.
Philippine peso is on the other end of the spectrum, where the external balance because of exports, the remittance story, all of which haven't been as strong as we would have liked to have seen. So I think the peso could underperform, the Thai baht could do well. So there are a number of relative value opportunities in the EMFX space.
Eric, tell me about Dolly Yen these days. I've been a financial journalist for 20 years and I remember this being such an important part of the conversation, but we haven't spoken about it lately. It has been very quiet for the last couple of years and a big part of that has been the Bank of Japan's monetary policy.
What's happening lately is that the Bank of Japan appears to be shifting its monetary policy ever so slightly away from its long-standing yield curve control policy. According to our expectations, ultimately they will move monetary policy setting away from a zero interest rate. With inflation picking up in Japan, we have felt for a while now that very aggressive monetary easing was no longer appropriate for the current economic setting.
But it's taking a while for them to move along that normalization path. For Dollar Yen in particular, it's experienced exceptional volatility over the last couple of years. We went from just over 100 to roughly 150.
We're now back around 130. These are big, big moves in a short period of time. The move from 150 back to 130 today was really in response to the decline in US interest rates since October.
The Japanese Yen has historically been a safe haven currency, yet that didn't happen last year and the question is why. One of the reasons we believe is a change in correlation between equities and bond markets. Last year, equity markets went down and yet US interest rates went up instead of going down.
That led to a significant widening of the dollar versus yen interest rate differential which took Dollar Yen much higher. What I think you'll see this year as interest rates are normalizing is if equities were to go back down again, you would see that correlation reassert itself and Dollar Yen would be a very good vehicle for expressing a negative view on risky assets. Let's get into the credit markets.
Gausik, it's still a tough situation for borrowers in EM. But because of this recovery, this ceasing of the rate hiking cycle, is that something that's likely to ease up this year or should we still be watching this closely? I think the worst is perhaps behind us.
Clearly the whole pricing of higher rates and tightening of liquidity conditions that we saw last year was very tough from a primary market standpoint. This impacted all of credit market, investment grade as well as the high yield sector. The high yield sector was completely shut off from the market and large parts perhaps will remain shut for an extended period.
But there are clearly, from a primary market and activity standpoint, things are starting to look up. I think there are certain high yield issuers that can access the market, if not early in the year, but perhaps later in the year. But certainly for the IG space, the market is going to be open and they will be coming to the market in fairly large size.
But EM will probably have to live with these higher rates and a number of EM countries will primarily rely on bilateral funding. They'll have to go into the debt restructuring window. It's going to be tough for a lot of high yield issuers.
But overall, I think the market is perhaps better than it was three, four months back. What I'm picking up is there are actually still quite a few challenges out there. No doubt.
But I think with what is already priced in and if the market is correct and we do get rate cuts as well, I think there will be some positive capital appreciation gains for duration assets as well. Eric, where are you positive, underweight, neutral on bonds? Anything that you want to highlight?
If we believe long-term U.S. interest rates have peaked and therefore that measures like term premium or interest rate volatility have peaked, then that means the high yielding markets in EM should offer potentially interesting values. Let's just talk about this Chinese economy and the idea of it roaring back to life. This could be a big injection for commodities in general.
Gaushik, I wanted to get your reflections on that possibility. If the real estate sector is going to come back, I think you will see some base metals and that sector of the economy do better. Oil demand will pick up as domestic economy picks up in China.
All of that will be supportive for commodities for this year. On the infrastructure front, which has been one of the growth segments and really supported commodities in the past, we don't necessarily think that infrastructure is going to be a big driver this year. We saw a very strong infrastructure push last year, but for this year, I think unless we get real estate really performing very strongly, which is probably more a second half story, infrastructure is probably going to be less of a driver.
Eric, when someone says recovery possibility in the second half, the sense is that we will have demand for commodities going up in tandem with it. Is that a sure bet? Nothing is a sure bet in today's world.
The probabilities are in favor of a decent commodity story. I think we will also see, and I'm sorry to harp on this topic again, is divergence. Last year was a year where we saw a surge in energy markets, in oil, in natural gas, retail gasoline, etc., largely because of the military conflict in the Ukraine, but also because of various supply chain problems around the world.
This year and last year as well, we saw a big decline in a number of these energy markets, but as Kaushik mentioned, base metals, copper, especially iron ore, really picking up pace over the last few months, and I think that that divergence will continue. We're also seeing, and this is in a world of difficult geopolitics, some easing in the geopolitical tensions between China and Australia, and that may free up China to take on more commodity supply from Australia, and we may see some of those base metal markets benefiting from increased activity. Okay, last question to you, Eric.
Eric is also the person behind the surprises report for 2023, and it's really well worth listening to. If there was one thing that could throw these expectations of a recovery in the second half off course, which surprise would you pick out? Embedded in one of the surprises was a discussion of the technology space, and the reason we mentioned it is this elevated level of financing costs, and what that means for both corporate and sovereign borrowing.
For a number of private sector companies and industries, the ability to borrow, to sustain these emerging business models is really critical, and even though financial conditions have eased a little bit, we still have an elevated level of interest rates. One of the things that we worry about is increased stress in private credit markets. That would be a real problem in terms of financial stability.
The other one is, and we've talked about it a few times, that we have a positive expectation for China's recovery in the second half, but I think a real surprise for markets and for EM sentiment would be as if that just never materialised in 2023, and it was a delayed story until 2024. I think that would be destabilising for markets. Well thank you both.
Eric Robertson, Standard Chartered Global Head of Research and Chief Strategist, and Gosik Rudra, Global Head of Fixed Income Research and Head of Asia Research. I have hosted a number of podcasts with both of these lovely gentlemen, so please do check out the podcasts that we have produced before, but for now, on behalf of Standard Chartered, I'm Aneesha Tank. It was great to have you with us.