Economic & Market Outlook – August 2023
The second quarter of 2023 has been a bit of a rollercoaster ride for the financial markets. There has been good news, bad news, and some surprises along the way. Let’s take a look at what happened and what we can expect for the rest of the year.
The good news: The economy is recovering
The global economy has continued to recover from the Covid-19 pandemic, as more people got vaccinated and more businesses reopened. The US, China, and Europe were the main drivers of growth, as they showed strong signs of improvement in their output and employment. The International Monetary Fund (IMF) raised its forecast for global growth in 2023 from 5.5% to 6%, saying that “the outlook presents daunting challenges related to divergences in the speed of recovery both across and within countries and the potential for persistent economic damage from the crisis.”
The financial markets cheered the economic recovery, as it boosted the confidence and earnings of consumers and businesses. Global equities gained 2.6% in Q2, with the US being the best performer among major markets.
The bad news: Inflation is rising
The flip side of the economic recovery was the rise in inflation as supply chains bottlenecked and pent-up demand pushed up prices of goods and services. The global consumer price index (CPI) rose 3.8% year-on-year in May 2023, up from 2.4% in February 2023. The US CPI rose 5% year-on-year in May 2023, the highest since August 2008. The core CPI, which excludes food and energy prices, rose 3.8% year-on-year in May 2023, the highest since June 1992.
The financial markets have been spooked by the inflation surge, as it raised the fear that central banks would have to raise interest rates sooner and faster than expected to keep inflation under control. Global bond yields rose sharply in Q2, especially in the US, where the yield on the benchmark 10-year Treasury note rose from 1.74% at the end of March 2023 to 1.95% at the end of June 2023. This resulted in a negative return of -1.9% for US Treasuries in Q2. Global bonds also posted a negative return of -1.4% in US dollar terms in Q2.
The surprises: Central banks are hawkish
The biggest surprise of Q2 was the change in tone from some major central banks, which signalled a more aggressive stance on monetary policy than expected. The US Federal Reserve (Fed) surprised the markets by announcing that it would start tapering its bond-buying programme later this year, and that it expects to raise interest rates twice by the end of 2023. This was a big shift from its previous projection of no rate hikes until at least 2024. The Fed also raised its inflation forecast for 2023 from 1.8% to 3.4%, but said that it still believes that inflation is transitory and will fall back to its 2% target over time.
The Bank of England (BoE) also surprised the markets by saying that it might have to raise interest rates sooner than expected if inflation continues to rise above its 2% target. The BoE said that inflation could fall to 3% by the end of this year, before finally returning back to its target over time. The BoE also reduced its bond-buying programme by £50 billion, but said that this was not a signal of tightening monetary policy.
The European Central Bank (ECB) was less hawkish than the Fed and the BoE, but still hinted at some tapering of its bond-buying programme later this year if the economic outlook improves. The ECB said that it would maintain its current pace of bond purchases until at least September 2023, but that it would reassess its policy stance in the coming months based on the inflation and growth data. The ECB also raised its inflation forecast for 2023 from 1.4% to 1.9%, but said that it still expects inflation to remain below its 2% target over the medium term.
What’s next: Cautious optimism
So, what can we expect for the rest of 2023? The global economy is likely to keep growing, but at a slower pace and with more uncertainty. The vaccination programme should help more countries to reopen their economies and resume normal activities. But the emergence of new variants of the virus could pose a risk to the public health situation and the policy response. Inflation could cool down in the medium term, as these temporary factors fade and as central banks tighten their monetary policies gradually and carefully.
We consider that the financial markets will likely remain volatile and vary across asset classes, regions, and sectors. We think that equities could still do better than bonds, as they benefit from improving corporate earnings and valuations. But equities could also face some challenges from higher bond yields, tighter monetary policies, and geopolitical tensions. We consider that a balanced approach to equity investing is a good idea, with a focus on quality companies that can grow and make money in different market conditions.
Bonds could face a tough environment in the second half of 2023, as inflation expectations stay high and central banks signal a more hawkish stance on monetary policy. We consider bond yields will rise further in the US and other developed markets, which will hurt bond prices.
To summarise, investors should keep a long-term view and a disciplined approach to investing in the second half of 2023. We will therefore continue to work with you to assess your objectives and ensure you have a well-balanced portfolio that matches your attitude to risk and capacity for loss. We will consider what impact the current stage in the economic cycle has on your exposure to various assets. Remember, volatility can be partially mitigated by diversifying investments suitably across a broad range of asset classes.
For clarification of any points discussed above and any future independent advice regarding your own financial planning, please do contact us on 01626 833225 or email [email protected]
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