Pandemic-related supply shortages and Russia’s war in Ukraine drove inflation to 40-year highs in 2022. Excepting energy and agricultural commodities, virtually all asset classes saw losses last year, resulting in one of the worst annual performances in history for mixed mandates. Equity rallies, usually justified by speculation of a shift to less aggressive tightening on the part of central banks, usually lasted only a few weeks. Looking to the year ahead, the market is likely to continue to focus on the outlook for interest rates and inflation. While it looks as though the peak in inflation has been passed, it is unlikely to return to the central banks’ target level of 2% in the foreseeable future. This will continue to keep the markets on their toes.
As in 2022, the outlook will be strongly influenced by the development of inflation. In the near term, central banks will continue to tighten their monetary policy, albeit less aggressively than during the summer and autumn of last year. Since short-term interest rates have risen more sharply than yields on long-term bonds, the yield curve has inverted in many countries, in some cases markedly. In the past, yield curves inverted to this extent have been seen as reliable indicators of an impending recession. Up to now central banks have been prepared to risk a more likely recession as the price to be paid for their policies designed to bring about a rapid decline in inflation. But as economies slow, so inflation pressures should diminish, and central banks can be expected to react to this by shifting their policies in the direction of easing. How soon and how quickly this happens is uncertain. Policy makers will not want to risk stoking inflation once more with a too-rapid pivot in the direction of monetary stimulus.
In the Eurozone, the monetary policy environment is more problematic than in the US or Switzerland. Year on year inflation in the Eurozone reached double digit figures in October and November but fell back to 9.2% in December. A now-stronger euro and falling energy prices are serving to decrease inflationary pressure thanks to falling import prices. Set against this, cost inflation for services is still rising. Finally, the high indebtedness of southern peripheral countries within the Eurozone poses limits on the extent to which monetary policy can be tightened to fight inflation. “Fragmentation” among member states and political tensions must not be fueled even further. Thus, inflation in the Eurozone is likely to remain higher, and to stay elevated longer, than elsewhere in the global economy.
Under its previous strict lock-down policy response to covid, China shut down completely many of her production facilities, causing or accentuating global supply bottlenecks. Severely restricted output levels in China, with knock-on effects elsewhere in global production chains involving China, depressed the world economy between 2020 and 2022. China’s recent shift in the direction of tolerating a freer circulation of the virus should improve her growth prospects, but if covid circulates in an uncontrolled way there is the risk that China’s health system will collapse under the pressure.
The real estate crisis hangs as a sword of Damocles over the Chinese economy. Nevertheless, China’s low inflation allows her central bank freedom to ease monetary conditions if required, possibly by allowing a deferral of mortgage interest payments. The outlook remains unsettled.
Covid and the policy response to it as well as the housing crisis continue to pose a significant threat to both the Chinese and the global economy.
Given trends elsewhere, Switzerland experienced surprisingly low inflation last year. On a year-on-year basis, it peaked at 3.5% in August and was 2.8% in December. Especially in relative terms the Swiss economy is in robust form. Growth in 2022 was around 2%, although momentum weakened over the course of the year and it is expected this trend will continue in 2023. The labor market remains tight, and we think there is a good chance that Switzerland will avoid a recession this year.
tock markets corrected significantly in 2022. High inflation prompted central banks to raise interest rates sharply, and this tightening is expected to continue in 2023, albeit at a slower pace. Higher interest rates boost financing costs and tend to produce asset price falls. Margins and profits will come under increased pressure in 2023. Falling profits combined with lower valuations imply lower price targets for equities. Meanwhile, the quantitative tightening of monetary policy will siphon off liquidity, weighing on the equity markets. Although there are many cross currents and volatility is likely to remain elevated, the resulting price corrections should create buying opportunities over the course of 2023.
The war in Ukraine, sanctions against Russia and Russia’s cutting-off its gas supplies to Europe have destabilized the energy markets. Last year’s build-up of reserves in anticipation of winter caused gas prices to skyrocket in the autumn with important knock on effects in the electricity markets. The Organisation of Petroleum Exporting Countries and Russia (OPEC+) is tightening global oil supply, aiming to keep prices high. We do not expect much change from OPEC+ near term. However, falling fuel prices and a favorable base effect mean that overall energy cost inflation is falling and this should continue.
Disappointing gold despite high uncertainties
Gold disappointed in 2022 despite geopolitical uncertainties and high inflation. Higher interest rates and a strong dollar were strong negative influences on the price of gold. The trend in interest rate expectations should turn more favorable and it’s reasonable to expect the now overvalued dollar will come under pressure. Both factors should have a positive effect on the gold price.
Central banks have been forced to counter the sharp rise in inflation with significantly higher interest rates, accepting in so doing an increased risk of inflation. The chance of a “Fed put” (an easing of monetary policy) is therefore low at present. Nevertheless, inflation rates have peaked or will soon do so thanks to a favorable base effect. Market participants now expect key interest rates to peak at around 5% in the US in the first half of 2023 and at around 3% in Europe in the second half. Real interest rates are thus becoming increasingly attractive. We recommend slowly reducing the underweight in the bond allocation
Since the US Federal Reserve has been the most aggressive in raising interest rates last year, the US dollar appreciated strongly in 2022 due to the rising interest rate differential. In our view, the US currency is now overvalued against many currencies. (Against the Swiss franc, however, it should continue to move in a range between 0.90 and 1.00.) The euro remains under pressure due to the political uncertainties in the peripheral countries and the tight energy supply situation. In addition, the ECB is confronted with the dilemma of having to counter high inflation with interest rate hikes on the one hand while not exposing the highly indebted countries within the Eurozone to an additional financial burden on the other. The franc, as a crisis-resistant currency, should continue to appreciate thanks to Switzerland’s low inflation and relative stability.
Contact: Christoph Sieger, Portfolio Manager
Telephone: +41 58 680 60 56
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In the latest Aquila Focus, Nicolas Peter, Head of Banking & Investments, discusses the continuing rally in US tech stocks and the lack of an interest rate cut in the USA for the time being.
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In 2023, numerous geopolitical risks came to the fore, supplemented by interest rate hikes by central banks in the fight against inflation. The conflict in Ukraine will soon last two years. In addition, the situation in the Middle East has worsened, particularly between Israel and Hamas. An escalation of the conflict to neighboring Arab countries has been prevented so far. Economic weaknesses are also evident in two of Switzerland's key trading partners: China and Germany. These developments are leading to a lack of important impetus from foreign trade. Geopolitical issues will continue to play an important role in the coming year. However, the past has shown that the impact of such events on the global financial markets is often short-lived.
Fewer sustainability investments, but more investments in pharmaceutical companies and the healthcare sector. Artificial intelligence en masse, but shares instead of gold. These are some of the resolutions of independent asset managers in Switzerland for the first quarter of 2024, according to the latest AVI Index.
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