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Some of the forces weighing on markets last year are now reversing. But we don’t think that means recession can be avoided in the U.S. and Europe – or that central banks will come to the rescue as recession takes hold. Here’s a summary of our January 2023 Macro and Market Perspectives Report, “Reversals, but recession without rescue.”
Both headline and core inflation look set to fall a lot in developed markets this year as energy prices fall back and goods prices decline. But we don’t think inflation will settle right back down at central banks’ 2% targets. Going from over 9% to 4% will be the easy bit. Getting it to settle below 3% will likely be much harder, and is not a given.
That’s because tight labor markets are creating wage pressures. In our view, labor market tightness is being misinterpreted as a sign of economic strength. Instead, it reflects constrained labor supply: In the U.S., an aging population has reduced labor participation; in Europe, an expanded public sector has reduced the pool of workers that private-sector companies can hire from. High wage pressure could only be eliminated with a serious recession. We will be in the unusual situation where recession does not result in subdued wage growth.
It’s possible that inflation could come down further than we expect. Goods prices could fall faster than expected, and companies might not have the pricing power to pass on higher wage costs. While this could be better news for inflation, it would be bad news for profitability.
But contrary to market expectations, we don’t see central banks cutting rates at any point in 2023, even if inflation does fall faster than expected. They will need to be convinced that inflation is falling all the way to 2% before reversing course and won’t be able to declare victory for a long time.
Markets are taking comfort from currently resilient growth in the U.S. But that near-term resilience won’t prevent a recession in developed markets, in our view. We expect a mild one this year as continuing rate hikes and the lagged effects of past hikes meet other drags. In the U.S., that is the depletion of consumers’ pandemic savings by the second half of the year. In the euro area, rate hikes will meet the energy shock that, although smaller than previously expected, is already dragging on activity.
In China, we expect the lifting of Covid restrictions to power a temporary growth spurt this year, with 2023 calendar growth surpassing 6%. But that spurt won’t be as strong as might have been expected with reopening, because fading developed market demand for Chinese goods exports are striking a huge blow to overall growth. Once the reopening has run its course, we expect future growth to average significantly below pre-pandemic rates given the country’s aging population.
What does this mean for investors? Falling inflation increases our conviction that central banks have regained some control and will be able to stop hiking at some point. On a multi-year investment horizon, we are already constructive on risk assets. But on shorter investment horizons, we remain underweight developed market equities and prefer credit and short-duration fixed income assets.
Falling inflation has spurred market hopes that it is already on its way to target without a recession, and yet central banks will still start an easing cycle. These hopes could persist in coming weeks. But getting inflation down close to target will require higher rates and recession. We think markets will be disappointed. As they adjust to this reality, the conditions will be created for a more constructive environment later in 2023, in our view.
View the full report from the BlackRock Investment Institute, “Reversals, but recession without rescue,” by Jean Boivin, Head, BlackRock Investment Institute, Alex Brazier, Nicholas Fawcett, Macro research team, with contributions by Serena Jiang and Filip Nikolic of the Macro research team.
Alex Brazier is Managing Director, Deputy Head of the Blackrock Investment Institute at BlackRock Inc.
Disclaimer
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date indicated and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any of these views will come to pass. Reliance upon information in this post is at the sole discretion of the reader.
© 2023 BlackRock Inc. All rights reserved. iSHARES and BLACKROCK are registered trademarks of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. This article first appeared January 16, 2023, on the BlackRock Investment Institute website. Used with permission.
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