- The US Fed will take a pause this year
When will it happen? When the US Central Bank reaches its target interest rate range of 5%-5.25%. The US Fed's current interest rate is 4.5%. That leaves 0.5-0.75% to reach the target. Hedge funds predict that the US Fed will raise the rate by 0.25% at each of its meetings in February, March, and May. And then, the Central Bank will take a pause until the end of 2023. Officials suggest that they may not cut rates until 2024, given their concerns about the sustainability of key components of inflation. The ""hawkish"" rhetoric is likely the result of concerns that the recent sharp drop in Treasury bond yields and the dollar, combined with narrowing credit spreads, is weakening financial conditions. Nevertheless, the lower core inflation numbers seen in October and December, combined with poor real estate data and weakening business confidence, have led the market to expect a rate cut starting in the second half of 2023.
- Europe goes into a recession
Lower energy prices have temporarily halted Europe's economic slowdown. But most indicators still remain weak. Recession in winter quarters still looks very likely, though perhaps not as deep. In the first quarter, further rate tightening by the ECB by another 50 bps is possible, as well as the beginning of a gradual reduction in the balance sheet. Money market pricing suggests rates will peak in June 2023 at about 2.75-3%, but some reckon the rate will end up higher because underlying price pressures remain strong, and expansionary fiscal policy may boost inflation. Can the ECB stay hawkish without hurting the European economy too much? Unlikely. And the same could be said for the Bank of England (BoE), making the prospect of euro and pound weakness an attractive scenario for this year.
- Bank of Japan (BoJ) likely to change its policy
The year 2022 saw most developed central banks move into some form of policy tightening to curb inflation. However, there is one notable exception as the Bank of Japan remains similarly loose and passive. Initially, in 2022, this led to a massive decline in the Japanese Yen on the back of a rising dollar index. But closer to the end of 2022, something began to change in Japan, and inflation began to rise. Of course, this is a far cry from spikes in inflation elsewhere, but with inflation at 40-year highs and the Bank of Japan still such an outlier in the global rate picture, the question remains, how long can they sustain policy? And maybe that will happen when a new BoJ governor is elected. The election will take place in the spring of 2023. It seems unlikely that by the end of 2023, we will have the same policies as before.
- China's economy is hanging on by budgetary injections
More and more local governments have switched to more lenient practices in implementing Covid measures in hopes of opening up the economy. But this has led to a new record outbreak of the disease. The World Health Organization (WHO) has criticized China's definition of COVID-19 deaths and warns that official statistics do not show the true impact of the outbreak. This negatively affects retail sales, manufacturing, and oil demand (China is the leading oil importer). China has increased export quotas for petroleum products in the first batch for 2023, indicating expectations of low domestic demand. Exports are also showing weakness due to high inflation in the US and Europe. The only support for the economy at present is budget spending, which is aimed at the development of advanced technologies and new energy.
- The war in Ukraine continues
In addition to the global story of high energy prices and inflation, the war in Ukraine continues. Russia does not want to give up its intentions to seize some Ukrainian territories militarily. Western countries help Ukraine both financially and with weapons, understanding that if Ukraine loses, Europe is next in line, especially the Baltic countries and Poland. It is already clear that Russia could not achieve its goals, so it continues to attack Ukraine's energy infrastructure. The entire civilized world understands that Moscow officials are no different from terrorists, but the fear of a nuclear threat makes it impossible to close the issue quickly. This year, the conflict is expected to continue, with a possible counterattack by the Ukrainian armed forces, which will try to retake captured territories with new weapons. All this will continue to affect financial markets, especially the energy crisis in Europe.
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