Markets Weekly podcast – 9 January 2023
With volatility characterising much of 2022, Andrew McDougall, Head of Geopolitical Risk at Barclays Group, ponders the geopolitical outlook for the next 12 months, touching on China’s intentions in Taiwan, the European Union and potential risks from the Middle East. While host Henk Potts examines economic developments over the festive season and considers inflation forecasts for the major regions in 2023.
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Henk Potts (HP): Hello. It’s Monday, 9th January 2023 and welcome to the Barclays Private Bank Markets Weekly podcast, the recording that will guide you through the turmoil of the global economy and financial markets.
My name is Henk Potts, Market Strategist for Barclays Private Bank. Each week, I’ll be joined by guests to discuss both risks and opportunities for investors.
Firstly, I’ll reflect upon the developments in the global economy over the course of the festive season and at the start of this year, share our updated macroeconomic outlook, and highlight our revised growth inflation and policy forecasts for some of the major regions. We’ll then discuss the geopolitical outlook and look at risks that could impact growth prospects during the course of this year. And finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.
2023 looks set to be another challenging year for the global economy as heightened geopolitical tensions, the ongoing impact of elevated inflation, the tightening of financial conditions, and limited fiscal headroom continue to weigh on growth prospects.
While we have become more pessimistic on growth prospects over the course of the past few months, we continue to acknowledge that labour markets remain robust. However, consumer, corporate and financial balance sheets still look very healthy. Excess consumer savings are still cushioning demand. The service sector continues to have plenty of room to recover.
For 2023, our forecast is that, given the probability of a contraction in activity in Europe and in the UK, and a now flat performance from the US, we expect advanced economies, in aggregate, will fail to generate any growth during the course of this year. We forecast that global growth will remain positive, albeit a very weak 1.8%, as China recovers from a depressed 2022, and the Indian economy grows around 5.2%, which would be the strongest growth rate amongst the major economies.
The inflation profile will continue to be a big driver of policy and sentiment in 2023. We expect price pressures to ease back over the course of the next year, partly due to technical and statistical factors, base effects, and fiscal support through intervention in energy markets. But, more fundamentally, tighter monetary policy will inevitably moderate demand. Inventory levels now look elevated, particularly on the retail side, which should take some of the pressure off goods. Commodity prices have been stabilising.
Labour market supply and demand dynamics are looking better balanced, which should take some of the heat out of wage inflation, and an easing of restrictions, plus an increase in capacity should help to resolve some of those supply constraints.
So where are we with inflation? Well, we think that price pressures have peaked, but headline inflation is still expected to remain above target levels through the course of this year in many of the key regions, but we do think inflation prints will become more digestible as the year progresses. For example, we forecast that global CPI will average 4.4% this year and then 2.8% in 2024. That compares to that 7.1% surge in prices that we saw in 2022.
Pressure from inflation has caused central bankers to pivot from promoting growth to curbing inflation during the course of last year. That policy normalisation process has been earlier and has been much more aggressive than we would have anticipated. But if, as expected, inflation continues to moderate into year-end, we can expect some of the intensity over the hiking narrative that dominated markets during the course of 2022 to ease, as officials try to orchestrate a softer economic landing than the harsh recession that some economists have been predicting.
Moving on to the regional breakdown, the US growth profile is expected to be subdued over the course of the next couple of years. Our forecast is for real GDP to grow at just 0.3% in 2023. That compares to growth of 2% during the course of 2022. The sluggish recovery, I think, continues during the course of 2024 where we’ve got growth of just 0.4% pencilled in.
In terms of US inflation, the November CPI print was 7.1%, which is still elevated but the slowest pace of increase that we saw during the course of last year. We are confident that the peak in US inflation is now behind us and that readings will grind lower over the course of the next 12 months. For example, we expect Thursday’s December CPI reading to come in at 6.4%, so US inflation gliding down to average 2.4% in the fourth quarter of this year.
In terms of the policy outlook in the United States, the Fed stepped down to a 50-basis point hike at the December meeting, pushing the target range for fed funds up to 4.25% to 4.5%. We look for a further 50-basis point increase in February, 25-basis point hike in March, then expect it to pause and maintain that policy rate of 5% to 5.25% through much of 2023.
Moving on to China, which of course had a miserable 2022 by its own standards, its growth profile slumped due to the rigorous enforcement of COVID restrictions, the collapse in property market, and weaker external demand. We estimate that China grew at just 3.3% in 2022, well short of that official 5.5% target growth rate. However, 2023 just could be a year of recovery after officials dramatically abandoned its economically damaging zero-COVID policy, implemented a comprehensive plan to shore up the housing market and boost its stimulus measures.
China, as I said, has finally abandoned it’s zero-COVID strategy by easing restrictive quarantine rules, scrapping mass testing, and finishing the practice of citywide lockdowns. And after more than 1,000 days its borders are reopening. We think that’s positive. Reopening disruption, I think, has been brought forward. We don’t expect China to retreat into a full lockdown. Growth is likely to have bottomed out in the fourth quarter and should gradually recover through the course of the first half of this year.
China’s new leadership appears to be refocusing on that growth agenda. Therefore, we are looking at significant improvement in terms of growth during the course of this year. We now expect China to grow at 4.8% in 2023.
In Europe, however, we maintain a pessimistic view for growth based on energy security concerns, weaker domestic demand, slower industrial output, and reduced levels of investment. Euro area inflation moderated to 9.2% in December, back into single digits for the first time since August. However, we expect price pressures will remain elevated through the course of 2023, in fact, averaging 5.7%. And when you look at headline and core inflation, it’s still projected to be above that 2% target level into 2025.
For the policy outlook, well, the European Central Bank guided that rates will still have to rise significantly at a steady pace to reach levels that are significantly restrictive. We, therefore, look for a 50-basis point increase at both the February and March meetings, with a forecast that the terminal rate for the deposit rate will be 3%. Our forecast is now that the euro area will contract by seven-tenths of 1% during the course of this year.
Finishing off with the UK, where the cost-of-living crisis, political turmoil, and policy confusion has created a negative backdrop. The UK’s impressive economic recovery has ground to a halt over the course of the past few months with output shrinking for the first time since the pandemic. The weakness has been broad-based. We’ve seen lower levels of household consumption, manufacturing PMI is in contraction territory, and even the boom that we saw in the travel and leisure sector has ground to a halt as households have slashed their spending.
The outlook for the UK economy, we think, remains gloomy as the cost-of-living crisis plays out. The Office for Budget Responsibility, for example, expects real wages to fall 7%. That’s the biggest drop on record, wiping out eight years of growth.
Meanwhile, tax hikes and spending cuts announced in the Autumn Statement will also weigh on growth prospects. That £55 billion of consolidation, 2.5% to 3% of GDP, increases the tax burden to 37.1%. That’s the highest since the second world war. The national debt, we think, will rise to 97.6% in 2026/27, a 63-year high.
Inflation continues to be a problem in the UK. It has been moderating but only very slightly. It came in at 10.7% in November, compared to that 41-year high of 11.1% in October, but looks set to remain elevated through the course of this year, averaging 7.9%, and not falling below that 2% target level till the end of 2024.
In terms of the policy outlook for the UK, the Bank of England hiked by 50-basis points in December taking the base rate up to 3.5%, that’s the highest that we’ve seen in 14 years. We forecast two further hikes, a 50-basis point hike in February, a 25-basis point increase in March, taking the terminal rate to 4.25% in the first quarter of this year.
But for the UK, I think given the multitude of pressures on the economy, we think that a deeper and more prolonged recession is inevitable. We forecast the recession will generate a peak to trough decline of 1.6%. For the calendar year 2023, we predict that real GDP will contract by nine-tenths of 1%, followed by only a sluggish recovery, seven tenths of 1%, in 2024.
I think while those headline numbers that we’ve been talking about this morning seem a little bit discouraging, we should acknowledge that the majority of the factors that made up our 2022 risk framework have already occurred. Therefore, with much of the bad news already incorporated into our low baseline growth forecast for this year, the potential for further downside from tail risk has actually reduced.
So, that was the global economy and financial markets last week. In order to discuss the impact that international relations could have on investors over the course of the next year or so I’m pleased to be joined by Andrew McDougall, Head of Geopolitical Risk at Barclays.
Andrew, great to have you with us today. Let’s get straight into your headline thoughts. What are the biggest geopolitical risks for 2023? Or will this year see a more stable geopolitical world, following the turbulence that we saw during the course of 2022?
Andrew McDougall (AM): Hi, Henk. Thanks. No, sadly I think we’ll see a bit more instability and fragility in the world of geopolitics in 2023. Following the Russian invasion last year and COVID, I think where still in a fragile period and China and the various problems in China will lead the list.
HP: OK. So, you say China remains top of the worry list for many investors out there. What is the actual risk there? We know that President Xi has been talking about his intentions towards Taiwan. Do you see this as posturing or is an actual invasion possible?
AM: An invasion is possible but it’s more posturing, I think. He’s told us exactly what he wants to do. He wants China to take Taiwan by 2049. His real strategy will be similar to his strategy on Hong Kong, so the one party, two systems. So, he doesn’t really want a military invasion and he wants to use economic strangulation as his main tactic. Now, that may stumble. There are real issues with that, and we could see a military invasion dependent on some of the US actions and Chinese responses to them.
HP: OK. Well, let’s try and take that into account as well. How do you see US/China relations developing over the course of the next 12 months? What economic weapons does the US have, and how will they use them? And, of course, how will China respond to those, and what does that mean for the overall picture?
AM: I think firstly what will happen over the next 12 months we’ll see a continued deterioration in US/China relations. As we’ve seen over the last few days, even German politicians visiting Taiwan has provoked China to simulate some exercises by putting ships and PLA air force planes across the median line into Taiwan.
We saw that just before the new year when the US defence spending was authorised, so authorising 10 million dollars’ worth of defence sales to Taiwan. Immediately, China responded by sending 70 jets across into the air identification zone in Taiwan. So, I think we’ll see a deterioration, a continued deterioration of relations, and the US/China economic relationship will deteriorate as well.
HP: OK. Let’s stick with the US and its relationships with other parts of the world and particularly the European Union, which appears to have deteriorated. Given the fact that the West is dealing with both Russia and China, how important do you think the pressure that we’ve been seeing on that relationship is?
AM: Yeah, I think this is one of the biggest issues for 2023, that EU-US relationship. And just going back to China, you’ve got a misalignment with the US and the EU on sanctions and on some of the policy. And we saw Chancellor Scholz visit China as soon as Xi Jinping consolidated power after the party congress in October, and I think that’s a significant issue between the US and EU.
This is also compounded by the Inflation Reduction Act, which the Europeans are struggling to come to terms with and come up with a suitable response. So that, I think, will be a significant issue this year.
The EU also have a number of internal dynamics at play, and you’ve got Hungary and a potential veto on some of the sanctions, particularly the Russia sanctions, and just some of these other internal issues. So, when the EU is struggling with trying to come up with a reasonable response to the Inflation Reduction Act, I think we’ll see some real issues.
On top of that, you’ve got, at the end of next year, the steel tariffs that could potentially be snapped back if there’s no agreement on the EU-US trade. So that’s just something to think about. And that will come about the same time as the Taiwanese presidential elections in January 2024, which will put real pressure on some of these relationships.
HP: Yeah, it’s interesting to hear the impact of those trade relations and what that could mean in terms of the geopolitical risk framework. Let’s think about Europe within itself. Do you think it’s going to be a bumpy 2023 for the Union?
AM: Yes and no. You’ve got the Swedish presidency starting in the European Union. You’ve got a very mild start, mild weather at the moment, which has helped significantly on the energy security for 2023. There are still real risks with gas storage for 2023/2024 winter, but it’s a pretty good start so far. So, energy might be OK, but we’ll have to see come summer.
Internal dynamics, other issues, I mean Hungary, Spain will become a bit of an issue this year with their elections and potential election of a government including a far-right party. So, there are political issues within the Union and that’s without the Russia/Ukraine issue and what may come of that because the pressure may really come to a head in Europe internally depending on what happens in Russia/Ukraine.
HP: One of the key elements, of course, that markets and people around the world will be focusing on is how the war in Ukraine plays out. What is your vision in terms of the prospect of a peace treaty? Or do you, indeed, think that the war there will escalate during the course of 2023?
AM: Yeah, I think the risk remains that the war will escalate. You’ve got Putin who is playing for time and will potentially mobilise more forces come spring. And what he wants to do is put more pressure on the Ukrainians by opening up more offensive operations potentially from Belarus in the north. You’ve got the Ukrainians trying to take as much ground as they can. They’re defending as much as they can at the moment, and they’re really desperate for more western weaponry. And we’ve seen the announcement by the French and Germans and the US to provide armoured vehicles and Patriot missile batteries, which could have an impact on the war.
But I think what we’ll need to see is a significant change to the military situation on the ground before any negotiations start, but we should potentially see some ceasefires on and off, and negotiations before the end of the year. But the risk remains that if Crimea is threatened quickly by the Ukrainians, then the Russians will be forced to act and how they act will be the real question.
HP: OK. Andrew, what are the other major areas of concern that you’ll be focusing on during the course of this year? We haven’t mentioned, for example, the Middle East yet. What are your thoughts around Israel, Iran and Saudi Arabia?
AM: Yeah, these are often forgotten risks, and you’ve got the new right-wing government in Israel who could have a significant impact on the Middle East this year. You’ve got the Iran/Saudi relationship, which could determine the stability of the Middle East and in particular the energy or the security of energy supply through the Persian Gulf.
Now, if Iran increases their enrichment of uranium and come closer to getting a bomb, then, potentially, Saudi will have to respond by getting a weapon from elsewhere. So, I think that could be a significant issue.
I don’t think Iran will fold. I think the regime is fairly stable at the moment, but the economic pressure on the Iranians may force them into some form of agreement with the US, but that’s a low probability or low possibility. But that risk is high that Iran/Saudi relationship will determine what happens in the Middle East. It’s being played out in the Yemen proxy war and Iranians and their proxies have threatened to hit shipping in the Persian Gulf and Horn of Africa, which they have successfully done in the past.
HP: Well, thank you know, Andrew, for your insight today. There’s no doubt that international tensions will continue to influence global growth prospects and returns for investors over the course of this year or so, so we’ll continue to monitor those situations very carefully indeed.
The focus this week will be on the US inflation print, which comes out on Thursday. We expect CPI headline to have fallen one-tenth of 1% month-on-month, having been up 6.4% year-on-year in December. In annual inflation terms for headline inflation, this would be the slowest pace since October 2021. Headline inflation is expected to be dragged down by a sharp drop in energy prices which included gasoline on average 13% lower in December compared to November.
We estimate the core CPI to have risen three-tenths of 1% month-on-month, 5.7% year-on-year in December. Core inflation pressures in the United States remain mixed with stronger services inflation driven by shelter costs overpowering ongoing goods deflation.
In the November UK GDP release on Friday, we look for a minus 0.1% month-on-month print. We expect squeezed disposable incomes following the increase in household energy bills in October to have weighed on services. We expect industrial production to print flat on the month as warmer than usual weather likely weighed on electricity and gas production, while we expect construction to continue to be resilient at 0.4% month-on-month, 6.2% year-on-year, as improved global supply-chain conditions is likely to have provided a tailwind.
And with that, we’d like to thank you once again for joining us. I hope that you found this update interesting. We will, of course, be back next week with our next instalment. But, for now, may I wish you every success in the trading week ahead.
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