Brave New Year 2023

global growth

J.P. Marín-Arrese | 2022 has witnessed an unmitigated rout in shares and bonds. The coming months might turn into additional bleeding as persistent inflationary pressures and robust employment data entice the central banks to tighten their monetary knot further. Other concerns also sap the investors’ risk appetite. China faces harsh times should it prove unable to cope with its endless pandemic stroke. Downbeat sales and profit prospects will soon surface as demand and growth turn sluggish.

While stocks are poised to bear the brunt of enduring uncertainty for months to come, the economy is displaying astonishing resilience. The energy crisis did not hurt as much as expected. Activity loses less steam than predicted. Labour markets show a strength that belies warnings of unavoidable recession. Prices gradually dent disposable incomes, but consumer demand still fares better than expected. As the economy fails to plunge into disaster as many observers forecasted, enhanced confidence will propel its pick up. The brave new year 2023 may exceed our expectations save for unexpected fresh events putting it off track. Recent record induces to nurture some mistrust in future developments.

Much will depend on the Fed’s ability to ensure a soft landing. The ECB will confine itself to preserve the euro pack unscathed, refraining from any move putting at risk that inner equilibrium. Jerome Powell faces the unpalatable challenge of preserving credibility by cutting short the current inflationary bout while preventing the economy from tail-diving. He has already entered no man’s land as rates approach the 5% barrier. Moving well beyond would entail extensive damage and mounting casualties. His strategy of dampening demand to cooling-off price pressures would backfire if leading to an economic crash. The tough choice for FOMC members is selecting a restrictive rate and sticking to it firmly until inflation abates towards its medium-term goal. Fortunately, they are individuals unlikely to cast their votes for rates higher than warranted. Paul Volcker was aware of such human frailties when fighting the spiralling prices that followed the 1970’ massive energy upheaval. He let the markets fix the rates, confining himself to set the money supply. Only then did rates rise beyond 10%, throttling inflation. 

The current supply shock has become largely subdued as the economy slows down and China’s troubles offset the shortages brought about by sanctions on Russia. Inflation will probably scale down quickly in the US as most price pressures built until late April. Monthly rises after that were relatively modest. Europe will face a more bitter and prolonged battle for reining in prices. Yet, fear of fuelling catastrophic divergence in the Eurozone will dispel any temptation to launch a full-fledged monetary offensive. The ECB will cross its fingers and deliver tough messages. But it will refrain from moving as far as the Fed.

While its recent rate hikes might look impressive, the Fed has carefully provided enough liquidity facilities to prevent a credit crunch. Moreover, its balance sheet decommissioning plan seems overcautious, indulging over a decade to restoring the pre-pandemic levels. Thus, medium and long-term market interest remains well below a restrictive mood. The fear of destabilising the debt market proves a formidable obstacle to selling the huge portfolio cumulated through the asset-buying programme in earnest.

Thus, while tightening seems high on the agenda, it fails to inflict real damage on credit and investment. Far less than the impact of confidence declining as economic prospects become lacklustre. Everything will depend on how promptly trust recovers and the economy sails away from the current doldrums. Mid-2023 might witness that shift.

About the Author

JP Marin Arrese
Juan Pedro Marín Arrese is a Madrid-based economic analyst and observer. He regularly publishes articles in the Spanish leading financial newspaper 'Expansión'.