Global economic outlook is set to be weaker in 2023 with the main driving force being the aggressive pace of monetary policy tightening led by the US Fed Reserve and major central banks to tame multi-decade high inflation. We do not expect a severe recession, due to the absence of financial imbalances. If the Fed does shift to a slower but much longer rate hike trajectory that extends and lifts its policy rate much higher than our projected 5% terminal rate, we will then have to expect a more negative impact on aggregate demand and in turn, a likely deeper/prolonged US recession as a consequence.
We maintain a neutral allocation to equities and expect a “Fed pivot” in 2023 or as soon as Dec 2022. Fixed income yields including government and investment grade bonds are now attractive given rich front-end rates. Given the substantial drawdown of a 60/40 Balanced portfolio of close to 20%, we remain constructive that a mixed asset portfolio should revert to a positive return for the full year.
We deem the recent equity price actions as a “catch-up” to fundamentals after a full year of negative investor sentiments as valuations de-rated sharply from the quick rise in discount rates. For now, we believe that the worst of growth de-rating is likely behind us and there would be less PE de-rating risk going forward. We expect stocks to bottom in 1H 2023.
The risk-reward is still most attractive at the short to intermediate maturities given the repricing on the front-end rates amid the Fed’s aggressive forward guidance. Longer dated investment-grade credits can also do well as long-end rates continue to price in weakening economic conditions. The credit allocation should continue to favor investment grade over high yield given rising risk of a US recession in 2023.
For 2023, we reiterate our confidence in gold as a portfolio diversifier of risk as well as a long-term safe haven asset to own. Once the Fed Funds Target Rate (FFTR) start to peak out after 1Q23, gold will then have a more meaningful recovery. We maintain our point forecasts for gold at USD 1,800 / oz in 1Q23, USD 1,900 / oz in 2Q23 and USD 2,000 / oz across 2H23.
FX & INTEREST RATES
With the Fed Funds Target Rate (FFTR) estimated to reach its terminal level of 5% by 1Q23, we reiterate the view that the DXY is also likely to peak in 1Q23 alongside US rates. For the front-end rates, upside potential for yields remain in effect into the end of the year and 1Q 23. That said, the magnitude of future increase ought to be lesser than what we have experienced thus far in 2022. From a medium-term holding period perspective; we prefer an opportunistic and positive stance on duration. We expect to see bond yields drift lower across 2023.