As we begin 2023, it is hard to believe that another year has come and gone.
After a year where global central banks hiked interest rates to levels last seen in 2008, in an attempt to combat the fallout of the Global Financial Crisis (GFC), central banks appear to be slowing their pace of monetary tightening. The US Federal Reserve led the charge, hiking interest rates by 425 basis points (bps) in 2022, compared to the European Central Banks’ hikes of 250-bps or the Bank of England’s and the South African Reserve Banks’ hikes of 325 bps. This has seen the US dollar outperform every other major currency in 2022 as shown by the DXY Index, which tracks the strength of the dollar against a basket of its major peers.
Despite slowing US economic growth, the Federal Reserve is primarily considering inflation and unemployment data as indicators in their decision to slow rate hikes and adopt a more dovish monetary policy stance. While inflation has started to decline, most notably in November, the US labour market remains strong which suggests that the Federal Reserve is likely to keep rates elevated in 2023.
In Europe, the European Central Bank has faced various challenges which include Russia’s invasion of Ukraine, global supply chain constraints, and the various issues facing the individual jurisdictions within the eurozone. The slower pace of tightening by the European Central Bank compared to the Federal Reserve saw the EUR struggle against the USD, falling below parity for the first time since 2003, and down 6.6% when compared to the USD since January 2022. The European Central Bank policy makers have noted that despite the key risks of a eurozone recession and the weakening EUR, the European Central Bank will remain hawkish going into 2023 until inflation is under control.
The pound sterling also struggled in 2022, declining almost 10% against the US dollar year-to-date. This weakness can be seen as a combination of the Bank of England’s slower pace of tightening coupled with the type of political uncertainty not usually associated with a developed economy. The conservative party has had three different Prime Ministers this year following the resignation of Boris Johnson in July amid the ‘Partygate’ scandal and Liz Truss’s resignation after only seven weeks, making her the shortest serving Prime Minister in British history. However, once this political uncertainty stabilised the pound rallied substantially against the dollar under the current Prime Minister Rishi Sunak. As with the European Central Bank, the Bank of England is likely to remain hawkish in 2023, as inflation in the UK is above % and is touted as enemy number one.
Despite unprecedented levels of load shedding together with political uncertainty surrounding President Cyril Ramaphosa and the Phala Phala scandal, the South African Reserve Bank has managed to contain inflation better than most other nations and with fewer rate hikes compared to the US and the Eurozone. At 7.4% the inflation rate in South Africa ends 2022 lower than that of the US, UK, and Eurozone inflation. Unfortunately, the rand weakened through 2022, against the greenback by 8.9% and the euro by 2.25%. For the rand to stage a meaningful recovery there are many factors that will need to change. This includes a sustained weakening in the dollar, the opening of the Chinese economy and reduced load shedding. As a result, the South African Reserve Bank will remain hawkish into 2023 until inflation is contained within the target range of 3 – 6 % .
Chinese policymakers are anticipated to loosen economic and COVID-related policies in 2023 to bolster the country’s economy, though it is uncertain whether these measures will merely stabilize economic activity at moderate levels or drive a significant increase in growth. While a positive view of the Chinese economy in the second half of 2023 may be warranted if there is conclusive evidence of a major growth catalyst, investors are likely to remain cautious towards China-related assets due to ongoing challenges following their zero COVID policy, weak income growth, low private sector sentiment, and structural issues in the housing market.
It is worth noting that central bank actions, such as raising interest rates, are typically taken in response to macroeconomic indicators and are intended to maintain stability. In this case, the increases in interest rates by global central banks were implemented in an effort to mitigate the global supply constraints and inflationary pressures that resulted from COVID-19. While the US dollar has outperformed other major currencies as a result, it is important to consider the potential consequences of these actions on individual economies and the global economic landscape.
Most of BCA Research’s strategists agree that 2023 will be a “a year of two halves”, one bullish, one bearish. They also agree that inflation will fall faster than expected over the first half of the year. However, the events of the past year have created significant uncertainty surrounding the longer-term forecasts and the cyclical economic outlook. US monetary policy has already effectively reached “tight territory”, which has often been a precursor to a recession within a year. Leading economic indicators are extremely weak, meaning that a dovish shift in monetary policy is likely required for a recession to be avoided. It is likely that, at some point in the coming year, we will see either a mild US recession or a further decline in risk asset prices in response to an anticipated recession in the US.