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A Way Too Early Look at 2023
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Andrew Kositkun Senior FX Advisor
Market consensus for 2021 growth sits firmly in the bullish camp, with very rapid growth expected in the U.S., continued growth in China and more moderate growth elsewhere. There is some disagreement on how much growth slows next year, but the real uncertainty lies in the 2023 outlook.
Both the Federal Reserve and fiscal authorities are trying to create a red-hot economy as quickly as possible. The combination of record-setting, and still rising, fiscal stimulus and no reaction function from the Fed should accomplish this. U.S. economic momentum could extend into 2023, leading to many “late-cycle” challenges despite only being three years into the expansion. As the output gap becomes increasingly positive, the trade-off between growth and inflation will worsen.
Today, inflation is at a point where the Fed can afford to stand back, but once inflation overshoots on a sustained basis, there will be some tough decisions to make. It remains to be seen how much of an inflation overshoot is acceptable, as well as how willing the Fed will be to risk a recession to stop the rise in inflation. This is especially relevant on the political side if higher rates will reverse some gains made by marginal workers.
It is possible the Fed gets a reprieve from inflationary pressures through a spike higher in productivity, as seen in 1995–2005, or through secular disinflationary forces, should global inflationary pressures remain low. Additionally, aggregate demand could slow sooner than expected. The key question here is whether this growth slowdown will lead to a recession or a “Goldilocks” situation of above-potential gross domestic product paired with modest growth and inflation. Barring a Goldilocks scenario, 2023 could shape up to be a challenging year, as strong growth and super-dovish central banks could mean a serious asset bubble at a time when the microenvironment will start becoming less friendly.
Sometimes slow and steady doesn’t win the race. Europe’s fiscal response to the crisis has been well below average for major economies. The COVID-19 situation is also extremely concerning. The spread of the B.1.1.7 variant has led to strict lockdown measures that could last until the end of April. This alone should suppress 2021 growth. Eventually, vaccine distribution should pick up, but summer tourist flows are likely to be below normal levels again.
Should the negative outlook play out, Europe could find itself stuck with perma-low inflation and policy rates. Moreover, should European officials prematurely reintroduce the EU’s strict rules around budget deficits and national debt in 2023, the region would be hit with another headwind.
Thankfully, potential Fed tightening should benefit Europe through a weaker euro. This comes through both policy divergence and the fact that Fed hikes are typically bad for risk assets and that the euro performs poorly in risk-off environments.
China has recovered quickly from the virus and has been able to maintain a largely open economy without major resurgence in the virus.
Unfortunately, the elimination of new problems ushers in older ones. Specifically, there are risks for a resumption of U.S.–China geopolitical tensions should each side feel that its economy has recovered and that it can negotiate from a position of strength. Keep in mind that pre-pandemic issues have not been resolved and that virtually all tariffs imposed in 2018–19 remain in place. China also hasn’t met its Phase One purchase targets, with the U.S. goods deficit actually growing. Most significantly, the tech sector remains an area of focus for the Biden administration.
Geopolitical concerns and pressure from U.S. policymakers could see manufacturers diversify away from China. Even without this, continued Chinese economic outperformance relative to the rest of Asia should lead to rising labor costs in China and accelerate the realignment of supply chains.
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