Key themes for 3Q 2023

  • Europe is weakening, China is disappointing, and the U.S. is approaching recession.
    While manufacturing has struggled, global growth has been supported by the services sector. Despite resilient U.S. growth, the foundations have been laid for a short and shallow recession later this year.

  • Inflation is decelerating, but at a slow pace, and will end the year meaningfully above target.
    Headline inflation is falling rapidly, but core inflation is proving to be a worry in developed markets (DM). Slower economic growth will be required to reach global central bank inflation targets. By contrast, emerging market (EM) inflation has fallen below DM inflation.

  • Most central banks are not done with monetary tightening; rate cuts off the agenda in DM.
    Stubborn core inflation has led to a repricing of central bank rate hikes, with further hikes to come in most DM economies, including the Federal Reserve (Fed). Inflation caution also implies that rate cuts will not start in 2023.

  • Equities will come under pressure as earnings weaken and further rate hikes test valuations.
    Notably, as a U.S. recession will likely be short and shallow, any equity pullback will likely be short and shallow. The following recovery will likely be reasonably swift, requiring a nimble and active response from investors.

  • High-quality fixed income offers stability and income in this unfolding economic backdrop.
    While higher-quality bonds will likely outperform and provide important diversification benefits, the mild recovery implies high yield (HY) defaults may not spike significantly, and elevated HY yields could provide a decent cushion as spreads widen.

  • Alternatives provide important diversification against traditional equities and fixed income.
    Inflation is decelerating but remains sticky and elevated, so inflation mitigation via infrastructure remains crucial for investors. By contrast, the slowing growth outlook will further depress commodities and natural resources.