By Claire Contri, Markets Editor at The London Financial
December 2022 marked the end of a challenging economic and financial year caused mainly by rising prices, supply bottlenecks, an energy crisis in Europe, and a global economic slowdown. 2023 promises to be a year where more regulation and requirements around transparency become marketplace realities but a global recession remains imminent.
2023 is expected to be a challenging year (again)
According to economic forecasts, the energy crisis will continue to affect Europe, and inflation will remain high until 2024.
A report from the IEA found that Europe could face a natural gas shortage of 27 billion cubic meters in 2023. That’s equivalent to nearly 7% of the region’s annual consumption. To tackle this issue, the IEA has declared a set of measures that includes aggressive stockpiling and efforts to voluntarily reduce demand for gas by 15% between August 2022 and March 2023. Costing about €100 billion, the IEA encourages further actions to improve energy efficiency, boost the adoption of renewables, increase the use of heat pumps and encourage other changes in behaviour.
For instance, Sweden has been recognised for being an example of tackling both the energy crisis and climate change simultaneously. Indeed, according to the binding targets agreed upon in 2018, by 2030, almost a third of all the energy consumed in the European Union must come from renewable sources, and Sweden is helping lead the way. While 54% of Sweden’s power comes from renewables, the country targets 100% renewable electricity production by 2040. Furthermore, one of Sweden’s goals is to make its citizens responsible and accountable for their energy production. For example, the country is transforming homes into highly efficient ‘prosumers’: buildings that produce and consume the vast majority of their energy. In addition to assuring Sweden’s total independence from energy sources disrupted by the War in Ukraine, this also serves a bigger purpose: safeguarding the planet and its resources. Now, it is the EU states’ responsibility to see that the current energy crisis is an opportunity to make Europe more sustainable.
The Russo-Ukraine war has put considerable pressure on food and energy prices. Ukraine is a major exporter of wheat, corn, and sunflower oil. The Russian invasion disrupted exports, causing a rise in global food prices and leaving millions of people running on empty by the end of 2022. After decades of relative stagnancy, prices surged to levels last seen during “the Great Inflation” of the late 1970s and early 1980s. The consumer price index (CPI) peaked in June 2022 above 9%. Hence, regarding the future of inflation, experts seem to disagree. For example, even if financial damage has been done, especially for low-earning incomes, the number of people struggling with rising prices is expected to gradually fall back to just under a quarter by the end of this year, according to a Morgan Stanley report. Daniel Milan, managing partner and investment advisor representative at Cornerstone Financial Services, on the other hand, believes that “inflation will be far stickier than most anticipate, as the economy continues to absorb the massive surge in the M2 measure of money the Fed injected into the system in 2020 and 2021”.
In either case, will it be enough? Overall, if just under a third (30%) of households will take a hit to their finances because of rising prices, this rises to almost 80% among lower earners. As the Fed is expected to keep raising interest rates incrementally in early 2023 and then pause at some point, the hope is that inflation will continue to slide lower, giving the central bank scope to pivot away from tightening. “This feels more like the 2001 to 2003 period than 2009 or even 2020, when the Fed used both rate cuts and quantitative easing (QE) to stimulate the economy and the market,” says Carl Ludwigson, managing director at Bel Air Investment Advisors. “Without aggressive rate cuts and the return of quantitative easing, I would not expect a V-shaped recovery.” The main risk here is that the US efforts to tame inflation will ship that inflation to the rest of the world.
Regarding the state of the global supply chain, what the Global Supply Chain Pressure Index (GSCPI) showed us during these past months, is that there has been a moderate increase in October 2022 after five consecutive months of easing. This indicates that global supply chain pressures are falling back in line with historical levels should the War in Ukraine continue in the West’s favour.
2022 was the worst-ever year for U.S. bonds
2022 was the worst year on record for bonds, according to Edward McQuarrie, an investment historian and professor emeritus at Santa Clara University. That’s mainly due to the Federal Reserve raising interest rates aggressively, which clobbered bond prices, especially those for long-term bonds.
Bonds are generally a safe asset, the safest part of an investment portfolio. They’ve historically been a shock absorber, helping portfolios when stocks plunge. But that relationship broke down last year when it suffered a significant meltdown in 2022. “Even if you go back 250 years, you can’t find a worse year than 2022,” he said of the U.S. bond market.
Bond prices move the opposite as interest rates. Hence, if interest rates rise, bond prices fall. That can be explained because the value of an investor’s bond will now drop as new bonds are issued at higher interest rates. Those new bonds deliver more significant interest payments of their higher yield, making existing bonds less valuable and thereby reducing the price of the current bond and dampening investment returns. According to John Rekenthaler, Vice President of research at Morningstar, bond yields in the latter half of 2022 were among their lowest in at least 150 years, meaning bonds were at their most expensive in historical terms.
Even if it’s impossible to predict how bonds will behave in 2023, many experts think it’s unlikely bonds will do nearly as poorly. “We’re more likely to have bonds behave like bonds and stocks behave like stocks: If stocks go down, they may move very, very little,” said Philip Chao, chief investment officer at Experiential Wealth, based in Cabin John, Maryland.
So what should we expect for bonds in 2023? As the Federal Reserve is expected to continue raising interest rates, advisors say the increase is unlikely to be as dramatic or rapid as in 2022. “There’s no way in God’s green earth the Fed will have as many rate hikes as fast and as high as 2022,” said Lee Baker, an Atlanta-based CFP and president of Apex Financial Services. “When you go from 0% to 4%, that’s crushing.” “We won’t go to 8%,” he added. “There’s just no way.” The traditional dynamics of a 60/40 portfolio will likely return, advisors said. In other words, bonds will likely again serve as a haven when stocks fall.
What 2023 holds for the fight against climate change
2022 was the year of the 27th Conference of the Parties to the United Nations Framework Convention on Climate Change (COP27) in Sharm el-Sheikh, Egypt. 2022 was also the year for companies to step up their action to fight climate change. Indeed, according to Bloomberg, despite rising interest rates, falling stock prices, and persistent inflation, major companies increased their speed on their climate goals. It is the case, for example, of Patagonia, that has, in 2022, published a statement where the company committed to donating all future profits towards protecting the planet. Practically, this means that the company’s ownership has been transferred to two charitable trusts: the Patagonia Purpose Trust, and the Holdfast Collective, allowing profits not required to be reinvested into running the business to go directly towards fighting the effect of climate change. This action proved one thing: that purpose-led companies can change the world.
2022 was also marked when governments and institutions realized the importance of taking climate change seriously. In Europe, for instance, despite the energy crisis and high inflation, the European Union continued its process of formalizing the Green Deal. In essence, the Green Deal is composed of a “package of policies” aiming at transforming the EU into a fair and prosperous society with a modern and competitive economy white, reaching climate neutrality by 2050. Moreover, Biden’s administration signed the historical climate bill in the US. This bill, meant to fight climate change, raise taxes on corporations and expand health care coverage, will raise about $700 billion through corporate tax increases and prescription drug savings. It will spend about $400 billion on clean energy and health care provisions.
Hence, along with measures such as the EU’s Corporate Sustainability Reporting Directive (CSRD) or the Sustainable Finance Disclosure Regulation (SFDR), the world has realised the need to put words into action and keep its goal to adapt the current financial models to today’s unprecedented challenges.
Emerging markets: an optimistic outlook
COVID-19 hit emerging markets hard. Really hard.
In 2020, the International Monetary Fund (IMF) projected a contraction in the world economy of 4.9%, with advanced economies suffering an average 8% loss in output and Europe generally affected even more.
For emerging markets, where savings are low, government resources are few, high levels of political instability are everywhere, and where practical measures to mitigate the virus are complex, the impact of COVID-19 on these economies was huge.
What is the result today? While it will undoubtedly take a longer time for many of them to recover, there is some hope for other economies. For example, China’s decision to end its zero-COVID policy is expected to boost domestic consumption and help the economy. “We’re forecasting 5% growth in 2023, with most of that coming in the second half of the year when the economy is expected to fully reopen following the repeal of Covid-zero policies early in the year,” says Chief China Economist Robin Xing.
Another example of a positive comeback is in India. Indeed, the OECD predicts India will be the second-fastest growing economy in the G20 in fiscal 2023, thanks to a decreasing current account deficit, decreased government spending, and easing imported inflation. According to Chief India Economist Upasana Chachra, “India has the conditions in place for an economic boom, fuelled by offshoring, investments in manufacturing, and energy transition.”
Overall, is 2023 to be feared?
Step by step, it seems the situation is improving to a certain extent. However, what seems most noticeable is that opinions diverge, and we can’t know anything for sure yet.
In an interview with CNBC, Mark Zandi, chief economist at Moody’s Analytics, said a recession “probably won’t happen until the second half of 2023.” Even if the financial services industry has successfully demonstrated its ability to navigate unprecedented levels of instability, uncertainty remains. As to preparing for a downturn, Zandi said Americans should “spend, save, invest in the same way that they typically do” but stay cautious.
2022 showed that the world is slowly taking another step forward to tackle the 21st century’s most urgent issue: Climate change. Whether it is enough remains to be seen.
Stay tight, everyone. The future is happening now.
Claire is a French-American Senior at ESSEC Business School in France. She has already done several internships in finance and loves writing articles. She also has a strong interest in sustainable finance and firmly believes that business can be a force for good and lead to positive change. Claire also serves as the Editor-In-Chief of The London Financial. Last but not least, she enjoys meeting new people from different backgrounds and experiences the most!
You could definitely see your expertise in the work you write. The world hopes for even more passionate writers like you who are not afraid to say how they believe. Always follow your heart.