Monetary Policy

In this, our final report of a tumultuous year, we summarize our policy outlook for the “Big 4” central banks – the Fed, the ECB, the Bank of England (BoE) and the BoJ – and the associated bond market implications for 2023.

Following the release of the Bank Credit Analyst’s annual outlook, we unveil our key views for 2023. The investment strategy takeaway is that we want to lean into risk in the early part of the year but reduce exposure to it in the second half.

In this report, we discuss our most important investment themes for global fixed income markets in 2023, and present our main investment recommendations based on those themes. Our broad conclusion: an environment of slowing global inflation, much weaker global growth and less hawkish central banks will be positive for global government bond returns, but problematic for growth-focused spread products like corporate bonds.

In this <i>Strategy Outlook</i>, we present the major investment themes and views we see playing out next year and beyond.

For the first time in decades, the Fed is raising rates while the US Leading Economic Indicator has fallen into contractionary territory and the global manufacturing PMI’s new orders sub-index has dropped below 50. Hence, the outlook for global stocks is currently poor. However, the underperformance of EM equities versus the US is in a late stage. We are putting EM stocks on an upgrade watch list and recommend buying EM domestic bonds opportunistically.

Long-term deflationary forces in Japan are weakening, setting the stage for inflation to make a comeback over the remainder of the decade. Investors should prepare to structurally reduce exposure to Japanese bonds starting early next year. Higher Japanese bond yields will lift an extremely undervalued yen. To the extent that global growth should surprise on the upside over the next 12 months, Japanese equities could see some modest outperformance.

In this Special Report, we consider what some common monetary policy rules are recommending for the major central banks and derive conclusions on duration strategy and country allocation for bond investors. We conclude that rate hike expectations in most countries may appear appropriate given the current global backdrop of high inflation and low unemployment, but look elevated on a forward-looking basis versus slowing global growth and peaking global inflation.

The kinked supply framework helps explain why US inflation rose so suddenly shortly after the pandemic began and why the economy is likely to experience a benign disinflation over the next six months.

Central banker messaging after the latest rate hike announcements in the US, UK and Australia indicates a shift in focus from the pace of hikes to how high rates must rise to slow growth and bring down inflation. This represents the next stage of the global tightening cycle, where rates will go higher in countries where neutral rates are higher, like the US, compared to countries with lower neutral rates like the UK and Australia.

While there is much variability in company profitability, earnings contractions have commenced and appear to be broad-based. We expect earnings growth to deteriorate further into year-end. Companies are reporting concerns about the trajectory of future economic growth and the uncertainty that it brings. Consumer spending on goods has slowed sharply, while spending on discretionary services has surprised on the upside. Business-to-business spending is still strong.