The Fed pauses hikes…The Fed persists with hikes
Indeed, 2022 has been an abnormal year. Rising inflation, a hawkish rate-hiking environment, and geopolitical tensions have triggered volatility and sharp adjustments across various asset classes. What’s more, major economies are on the verge of recession.
While it may be premature to predict an end to these market adjustments, our experts believe that the central bank easing cycles will begin in 2023. Furthermore, the US Federal Reserve (Fed) may increase its Fed Funds rate to a peak of almost 5% or above by the first half of 2023. The nuance would be whether it’s a pivot or a pause.
Will we see a central-bank pivot in the first half? While monetary easing by developed-market central banks may occur before the end of 2023 (as growth concerns overtake worries about the inflationary backdrop), the Fed and other central banks could pause and maintain rates at current levels before changing direction. Inflation will have to unwind to a point where most central banks could pause and assess the impact of—to borrow a phrase from the Fed—cumulative tightening before the end of 2Q 2023.
If more manageable inflation fails to materialise, central banks will then face two options: choose to look through inflation (e.g., inflation now is no longer the only considered by the Bank of Canada in its decision-making process) or continue tightening beyond what has already been priced in by the market. The second scenario would likely lead to another bout of heightened financial market volatility.
If that happens, global central banks will continue to fight inflation, be vigilant of peaking inflation, and retain their hawkish bias. In turn, this would lead to a stronger US dollar. In other words, the status quo of 2022 will remain – pro-dollar, elevated rates and equity-market volatility, as well as a higher-for-longer inflationary environment. Headline inflation will continue to drive market sentiment, and if price rises haven’t peaked, central banks will need to be more restrictive with their monetary policies.
Asia is positioned for a fuller-economic reopening and a slow-motion recovery
In Asia, we see clear signs of economic re-opening amid increasing policy support from China. The broader Asian economy may benefit from a fuller economic reopening (for instance, mainland China, Hong Kong SAR, Japan, and Taiwan) and a recovery in tourism. South Asian economies are opening their borders amid higher vaccination rates. Notably, economies more exposed to declining global demand could be relatively worse off due to the looming slowdown or recession.