Economic risks heading into 2023
Linda Edees, investment executive at Foord Asset Management
While markets got swept up by the holiday spirit, central banks continued to aggressively raise interest rates globally. During November we saw another sobering set of 75 basis point interest rate increases in South Africa, the US, Europe, as well as the UK.
What’s interesting to note is that we are currently sitting with the unusual situation of having already experienced bear markets, but the recession that prompted them hasn’t started yet. Research from macro firm TS Lombard shows that no US bear market – caused by an economic slowdown – ended before the recession started, which means it may be premature to assume that the worst is over.
Linda Edees, investment executive at Foord Asset Management, notes that even if interest rates are nearing a turning point, there are still significant economic risks for the year ahead.
Economic risks heading into 2023:
1. This recent tightening cycle has yet to bite.
The market currently expects the Fed’s benchmark interest rate to reach close to 5%. That’s up from close to zero at the beginning of this year in the most aggressive tightening cycle in 40 years – yet we’ve still not seen a major impact on either US labour markets or US spending. Even though hourly wages have actually gone down in real terms, Americans are still spending – after an era of easy money, bad habits are hard to break. But instead of spending their stimulus checks, they’re spending on credit, and they’re spending their savings. The savings rate in the US is now at 2.3% – the 2nd lowest level on record.
2. There’s still a risk that inflation won’t fall as quickly as the Fed would like
This means that the risks to interest rates remain to the upside. With the US labour market tight, and spending still strong, the Fed is likely to err on the side of tightening too much rather than risk inflation becoming a longer-term threat. And while the rest of the world shares America’s inflation problems, we also remain tied to its interest rate cycle – so while the US is still hiking, most countries – including South Africa – will be forced to do the same.
3. Most governments are now stuck with a significant debt problem.
While growth rates were higher than borrowing costs, governments could borrow cheaply – and they did, with gusto. But with economies now slowing and borrowing costs rising sharply, several countries, including South Africa, could find themselves on an unsustainable debt trajectory unless they make painful fiscal adjustments. Recent developments on the political front in South Africa are a stark reminder that higher government bond yields are not a free lunch – they’re compensating investors for higher country risk premiums – In other words, investors need to be paid more because the risk of lending to countries like South Africa has significantly increased. And until we see a turnaround in the structural decline and significant reform that promote growth, we are likely to experience further bouts of market instability and a steady decline.
4. Housing markets in regions such as the US, Canada and Australia were all driven to very frothy levels due to excessively low interest rates and stimulus – but with both reversing, they are now vulnerable.
A significant drop in nationwide housing prices in these regions may be needed to bring mortgage payments in line with household incomes. If this happens, it will have significant negative economic ramifications.
5. Geopolitical risk
This still remains at elevated levels which increases the risk of negative events. The standoff with Russia that’s left Europe short of energy is a good example of how geopolitical issues can have a direct impact on economic growth.