The new world order is here - and bonds are back in fashion

Andrew McAuley

Credit Suisse

Global economic growth will generally stay low in 2023. Yet with monetary policy tightening likely to slow or end in 2023, Credit Suisse believes fixed income assets will become more attractive to hold.

Our year-ahead projection suggests we will see low global economic growth of just 1.6%. Although central banks will likely slow or end monetary policy tightening in 2023, we expect no rate cuts in any of the major economies. 

Against this backdrop, fixed income assets are likely to offer attractive opportunities for investors, while equity performance is seen staying muted, at least in the first half of the year.

After a challenging year in 2022, which saw persistently high inflation, aggressive central bank tightening and slowing growth, Credit Suisse expects 2023 to see recessions in the Eurozone and UK, and a growth recession in China. 

These economies should bottom out by mid-2023 and begin a weak, tentative recovery – a scenario that rests on the crucial assumption that the USA manages to avoid a recession. We expect economic growth to generally stay low in 2023 against the backdrop of tight monetary conditions and the ongoing reset of geopolitics.

But how will Australia fare?

Australia enters 2023 in a position of strength. Household balance sheets are robust, and unemployment is low. As a net exporter of energy and food, some of the drivers of global inflation aren’t having quite the same impact. That said, inflation is uncomfortably high, and the Reserve Bank will do what it takes to bring it down.

Likewise, the economic outlook for Australia is one of slower growth and higher unemployment. GDP growth will likely fall from 4.0% this calendar year, to about 1.6% in 2023, in line with the global average. Unemployment is expected to rise to 4.5% while inflation should top out at around 8% by Christmas and fall to a run rate of 3.5% by the end of 2023. 

Where is the terminal rate for Australia?

The Reserve Bank of Australia, like all developed market central banks, has a laser-like focus on bringing down inflation. Official rates have increased from 0.1% at the beginning of 2022, to 2.85% post the November rate decision, its highest level since July 2013. 

The RBA is committed to returning inflation to 2-3% over time, which means higher rates from here. We see a peak RBA rate of 3.6%, probably around July or August 2023, in line with bond market futures expectations. Fiscal policy will be a net detractor from economic activity. 

The recent budget sets the stage for lower spending and higher taxes in the future. Net government debt is expected to fall from 31% to 23% of GDP. The improvement is due to firm iron ore and coal markets as well as more people working and paying taxes.  

What about the US and China?

Credit Suisse expects US growth to average 0.8% in 2023. The probability of recession is high but is still not our base case. Inflation is beginning to moderate, but core PCE inflation is likely to remain stubbornly high at around 3% as of year-end 2023. We thus expect the Federal Reserve to continue to tighten aggressively, up to a terminal rate of 4.75%-5.00%.

We forecast below-consensus growth of 4.5% for China in 2023. Lower growth potential, fiscal consolidation and a slow shift away from the government’s zero-COVID policy are likely to constrain the economy. 

Our expectation is that any meaningful reopening will happen only toward the end of Q1 2023. 

What does this mean for assets?

Global equities are likely to deliver a muted performance in the first half of 2023, as the focus remains on the “higher rates for longer” theme. Sectors and regions with stable earnings, low leverage and pricing power should fare better in this environment. 

Once we near a pivot by central banks interest-rate-sensitive sectors with a growth tilt may become more attractive again.

Australian equities have outperformed in 2022 as the largest sectors, banks and miners have benefitted from better interest margins and strong commodity prices respectively. In addition, an under-representation in expensive technology stocks has buttressed the market. 

The ASX 200 is trading at around a 10% discount to its long term one-year forward price-to-earnings ratio, with an expected dividend yield of 4.5%, based on consensus. 

This attractive starting point is offset somewhat by the expectation company earnings will be downgraded as interest rate increases slow the economy.

With inflation likely to normalize in 2023, fixed income assets should become more attractive to hold, and offer renewed diversification benefits in portfolios. High quality, Australian dollar-denominated corporate bonds are particularly attractive with yields of close to 5% on offer for some instruments.

In early 2023, demand for cyclical commodities may be soft, while elevated pressure in energy markets should help speed up Europe’s energy transition. We think the backdrop for gold should improve as monetary policy normalization nears its end.

Finally, in alternative investments, we expect the environment for real estate to become more challenging in 2023 amid headwinds from higher interest rates and weaker economic growth. Further, we see opportunities for active management to add greater value, particularly for secondary managers, private yield alternatives and low-beta hedge fund strategies emerge.

Learn more

In our Investment Outlook 2023, we present an investment road map of what investors may expect with regard to the economy and the financial markets. To read the full version, please visit our website

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Andrew McAuley
Chief Investment Officer
Credit Suisse

Andrew McAuley is a Managing Director of Credit Suisse Wealth Management Australia. As Chief Investment Officer, he is responsible for developing discretionary and advisory investment strategies across multi asset class portfolios for clients in...

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