Growth: a balancing act – our Q3 2023 update

Life, personal and professional, is in many senses a balancing act. This is also true of growth and economic policy. 

Central banks must balance any need to hike rates to combat inflation with the danger of pushing their economies into recession. To make the right decisions, the Fed and its peers need to have both the correct data and the ability to assess it against both their specific needs and given mandates (which may include employment/growth as well as inflation control). The Fed currently faces particular challenges, for example, in assessing changes in financial conditions and to what extent they are due to policy tightening – or to other factors such as the regional banking difficulties.

Investors also need to perform a balancing act. Tactical decisions based on short-term market moves are not a sustainable source of performance; they need to take place within a strategic asset allocation (SAA) that is based on a broader assessment of structural economic and investment change.

This year, growth should mainly come from Asia: after an uneven start, China’s recovery is likely to strengthen in the second half of 2023 before slowing in 2024. By contrast, our base case for developed markets is a shallow recession or a period of only anaemic growth in 2023, followed by a modest recovery in 2024. Weak developed markets’ growth combined with persistent inflation may increase the risk of policy overtightening, as could any misreading of the apparent current strength of many countries’ labour markets.

We expect the Fed funds rate to peak soon at 5.25-5.50%, and the ECB deposit rate to rise (somewhat later) to a high of 4%. But a possibility of yet higher rates, and remaining inflation worries, mean that government bond yields are likely to rise further. Our central forecast is for 10-year U.S. Treasury yields of 4.20% and 10-year Bund yields of 2.80% at end-June 2024 – and they could go higher in the interim. Investors need to be prepared for re-steepening curves or less inverse curves within the forecast horizon.

Equity markets are likely to be held back by flat 2023 earnings and a realisation that, in a world of higher yields, equity valuations are not likely to return to previous levels. Persistent inflation would also pose some risks, despite the support that price rises can give to this asset class. But, with corporate earnings likely to start growing again in 2024, we see single-digit upside for most equity markets over the next 12 months.

Any balanced assessment of the situation needs to weigh up changing views on, for example, the possible timing and depth of a U.S. recession or the real strength of the current Chinese recovery. Assessments must also incorporate new and sometimes contradictory economic data. But there is a danger, I think, that the multi-faceted nature of the current situation encourages investors to retreat to overly simple analysis, for example by focusing on higher nominal yields rather than the major impact of inflation on real yields and managing fixed income in portfolios. This is not a time to rely on supposedly easy solutions: you need a sophisticated approach to both portfolio allocation and risk management.

Portfolios also need to be prepared for two key structural changes. First, the transition to a more environmentally sustainable economy will have multiple impacts on the global economy: this is not just a challenge for the energy sector. Second, artificial intelligence (one of our featured long-term investment themes since 2018), has now moved centre-stage in investor perceptions and is likely to stay there. We continue therefore to believe that you should consider complementing existing portfolio management with longer-term thematic investment, based around the interlinked issues of resource transition, population support and next phase technology. Balancing immediate portfolio management with identifying future growth opportunities remains key to achieving satisfactory long-term returns.

Christian Nolting 
Global CIO