January 5, 2023

2022 was a shocking year. Against the historic volatility of 2020 and 2021 — which saw the deepest global downturn on record, followed by the strongest rebound — 2022 growth outcomes were far more stable. But this year has been remarkably turbulent, with the global economy hit by multiple adverse shocks — from supply and demand issues spilling into labor markets and a third major wave of COVID-19 to Russia’s invasion of Ukraine.

Turning toward 2023, the monetary policy tightening drag is building and central banks remain on the march. Of the 31 countries J.P. Morgan Research tracks, 28 have raised rates. There is likely more to come. Based on its current guidance, the Federal Reserve (Fed) will have delivered a cumulative adjustment of close to 500 basis points (bp) on rates through the first quarter of 2023. Central bank activity is clouding the outlook for next year somewhat as the Fed, followed by other major central banks, is expected to pause hikes by the end of the first quarter of 2023. 
 

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The substantial rise in borrowing costs is already depressing housing activity and the sharp climb in the U.S. dollar is likely weighing on U.S. corporate profit margins. There are also increasing signs that credit conditions are tightening broadly. Tremors emanating from Emerging Market (EM) low-income commodity importers, U.K. pension funds and the U.S. crypto sector are not unrelated: they signal that rapidly tightening financial conditions generate stress that could spill over in ways that threaten macroeconomic stability.

“With the winter set to aggravate China’s COVID problems and Europe’s natural gas crisis, the global growth outlook remains depressed, but we do not see the global economy at imminent risk of sliding into recession in early 2023. The financial conditions drag is being cushioned by a fading of supply chain and commodity price shocks,” said Bruce Kasman, Head of Economic and Policy Research at J.P. Morgan.

Global consumer price index (CPI) inflation is on track to slow toward 3.5% in early 2023 after approaching 10% in the second half of 2022.

“Circumstances warrant considering a range of scenarios. The dominant event across different scenarios presented is a U.S. recession…but the timing of this break, the path of Fed policy and the reverberations for the rest of the world vary,” added Kasman.

After a year of macroeconomic and geopolitical shocks, investors responded by derating the S&P 500 price to earnings (P/E) ratio as much as seven times, while some speculative growth segments crashed 70-80% from highs.

Although fundamentals have been resilient throughout these shocks, this year’s constructive growth backdrop is not expected to persist in 2023. Fundamentals will likely deteriorate as financial conditions continue to tighten and monetary policy turns even more restrictive. The economy is also likely to enter a mild recession, with the labor market contracting and unemployment rate rising to around 5%.

“Consumers with a cushion of savings from lockdown have mostly exhausted their post-COVID excess cash and for the first time are getting hit by a broadening negative wealth effect from all assets simultaneously — whether that’s housing, bonds, equities, alternative/private investments or crypto,” said Dubravko Lakos-Bujas, Global Head of Equity Macro Research at J.P. Morgan.

“This proverbial snowball should continue to gain momentum next year as consumers and corporates more meaningfully cut discretionary spending and capital investments.” 

In light of these factors, J.P. Morgan Research is reducing its below consensus 2023 S&P 500 earnings per share (EPS) of $225 to $205 due to weaker demand and pricing power, further margin compression and lower buyback activity.

Upside and downside to this base case will largely depend on the depth and length of the recession and the speed of the Fed’s counter-response. Market volatility is also set to remain elevated (with the Volatility Index or VIX averaging around 25).

“In the first half of 2023, we expect the S&P 500 to re-test the lows of 2022 as the Fed overtightens into weaker fundamentals. This sell-off combined with disinflation, rising unemployment and declining corporate sentiment should be enough for the Fed to start signaling a pivot, subsequently driving an asset recovery and pushing the S&P 500 to 4,200 by year-end 2023,” said Lakos-Bujas.

The convergence between the U.S. and international markets should continue next year, both on a USD and local currency basis. The S&P 500 risk-reward relative to other regions remains unattractive. Continental European equities have a likely recession to negotiate and geopolitical tail risks, but the eurozone has never been this attractively priced versus the U.S. Japan should be relatively resilient due to solid corporate earnings from the economy’s reopening, attractive valuation and smaller inflation risk compared with other markets.

“Within developed markets, the U.K. is still our top pick. As for EM, its recovery is mostly linked to China. Tactically, the Asia reopening trade led by China is overdue and the activity hurdle rate is very easy, with further policy support likely. We expect around 17% upside for China by the end of 2023,” said Mislav Matejka, Head of European and Global Equity Strategy at J.P. Morgan.

Entering 2022, the view was the global oil market would remain tight but balanced, with Brent averaging $90 per barrel (bbl) for the year. With the onset of the war in Ukraine, J.P. Morgan Research opted to raise its 2022 average Brent price to $104/bbl and 2023 price to $98/bbl, with prices peaking in the second quarter of 2022 at $114/bbl.

“After maintaining our price view for eight months, we now opt to shave $8 off our 2023 price projections, on our expectations that Russian production will fully normalize to pre-war levels by mid-2023. Despite more pessimistic expectations for balances over the next few months, we find the underlying trends in the oil market supportive and expect global Brent benchmark price to average $90/bbl in 2023 and $98/bbl in 2024,” said Natasha Kaneva, Head of Global Commodities Strategy at J.P. Morgan.
 

Commodity price forecasts for 2023, with Brent averaging $90 per barrel, WTI averaging $83 and gold averaging $1,860 in the fourth quarter of 2023.   

There are strong reasons to expect a relatively robust 1.3 million barrels per day (mbd) of oil demand growth next year, despite expectations for the global economy to expand at a sub-par 1.5% pace in 2023. There is still substantial room for a cyclical rebound, driven by a continued normalization of demand for mobility fuels like gasoline, diesel and jet fuel to pre-COVID levels.

“Our forecast of a $90 Brent in 2023 centers on the view that the OPEC+ alliance (Organization of the Petroleum Exporting Countries and allies) will do the heavy lifting to keep markets balanced next year,” added Kaneva.

On the structural side, expansion of the world’s oil supply growth is expected to slow in 2024, reviving the need for OPEC’s crude. Growth from U.S. shale producers, traditionally the most responsive to changing market conditions, is expected to more than halve from 1.1-1.2 mbd this year and next to 0.5 mbd in 2024.

For base metals, 2023 will be a transitional year, with prices once again re-testing the lows approached earlier this year around mid-2023.

“After bottoming over mid-year, a more sustained recovery in base metals prices is set to unfold in the last few months of the year,” said Greg Shearer, Head of Base and Precious Metals Strategy at J.P. Morgan.

Relative to base metals, the outlook for precious metals is more positive, with all but palladium expected to end 2023 higher. With the Fed on pause, decreasing U.S. real yields will drive the bullish outlook for gold and silver prices over the latter half of 2023. Gold prices are forecast to push up to an average $1,860 per troy ounce in the fourth quarter of 2023.

“Even with a bullish baseline gold and silver forecast, we think risk is skewed to the upside in 2023. A harder-than-expected economic landing in the U.S. would not only attract additional safe haven buying, but the rally could become supercharged by more dramatic decreases in yields if the Fed more rapidly unwinds tighter fiscal policy,” added Shearer. 

Over the past year, the Fed has been forced to tighten aggressively, outpacing every tightening cycle over the last three decades.

For 2023, it is no surprise that inflation and Fed rate policy remain top of mind for investors: in the J.P. Morgan Research 2023 Outlook Survey, respondents ranked these two factors as the most important for U.S. fixed income markets in 2023, followed by U.S. recession risks. With inflation already showing signs of softening, the Fed is expected to deliver a 50bp hike in December, before dialing down the tightening pace further and delivering 25bp hikes at both the February and March meetings. It is expected to pause rate hikes thereafter.

“The almost 500bp of expected cumulative hikes is already delivering a commensurate tightening of financial conditions, which we believe will tip the economy into a mild recession later next year. With a slowing in aggregate demand, we project the unemployment rate will rise to 4.3% by the end of next year,” said Jay Barry, Co-Head of U.S. Rates Strategy at J.P. Morgan.

10-year U.S. Treasury yields are expected to fall to 3.4% by the end of 2023 and real yields are expected to decline.
 

55% of investors polled by J.P. Morgan in its 2023 Outlook Survey expect the Fed to be on hold through the first quarter of 2024 or beyond.

2023 should deliver the completion of one of the fastest and most synchronized Developed Market (DM) central bank tightening cycles on record, with most of them expected to be done by the first quarter of 2023. The growth profile will show divergence: the Euro area will likely face a mild recession into late 2022/early 2023, while the U.S. is expected to slide into recession in late 2023.

In currency markets, further dollar strength is still expected in 2023, but of a lower magnitude and different composition than in 2022.

The Fed pause should give the dollar’s rise a breather. Additionally, unlike in 2022, lower-yielding currencies like the euro are expected to be more insulated as central banks pause hikes and the focus shifts to addressing slowing growth — but this in turn makes high-beta, emerging market currencies more vulnerable.

Weak growth outside the U.S. should also remain a pillar of USD strength in 2023. “Some growth signals suggest an improvement outside the U.S., but we are skeptical of the longevity of this theme,” said Meera Chandan, Co-Head of Global FX Strategy at J.P. Morgan.

At 2.9% in 2023, EM growth looks to remain well below its pre-pandemic trend, slowing modestly from 2022. EM excluding China is expected to slow to a below-trend 1.8% with wide regional divergences. In China, the full-year 2023 growth forecast is 4% year-over-year, where two quarters of below-trend growth are assumed as the economy loosens COVID restrictions. 

Dwindling private sector savings will test EM’s ability to withstand continued tightening in global financial conditions and weaker global growth. 2022’s geopolitical stresses remain unresolved and represent two-sided risks for EM in 2023, while some key domestic political events will be followed closely — most notably the elections in Turkey and Argentina.

Disinflation is expected in 2023, but with few rate cuts across EM central banks and focused mostly in Latin America. EM ex-China and Turkey inflation is expected to halve to 4.3% by end-2023 compared with 7.9% in end-2022.

“Inflation is expected to remain a problem for central banks in roughly half of the core EM countries. Some EM central banks may start easing next year but most look set to keep rates high for longer,” said Luis Oganes, Head of Currencies, Commodities and Emerging Markets Research at J.P. Morgan.

Stubbornly high inflation, continued USD strength and a broader tightening in global financial conditions mean easing cycles are only expected to get underway in Latin America, Czechia and India. The rest of EM Asia, having lagged its EM peers in lifting off, is expected to stay on hold next year.

“The global and U.S. economic cycles will remain the primary drivers for EM assets in 2023. The worst moves for EM risky asset classes are seen in U.S. recessions with large widening in credit spreads and lower equity prices. EM has historically followed these patterns and we expect higher risk premia into a U.S. recession, although the moves may be mitigated by the selloff already seen in 2022,” added Oganes.