Executive Summary

Since our last quarterly economic update, the deteriorating energy crisis and policy mix have confirmed our forecast of slowing growth, sticky inflation and rising interest rates. For next year, we have identified eight songs and themes to keep your ear to the ground during the great energy quarantine:

#1. Slow Down. In 2023, we continue to forecast a mild recession in Europe, on the back of the energy crisis, and in the US due to the abrupt normalization of monetary and financial conditions. This triaging recession will test resilience. Stronger balance sheets, demand backlog and fiscal support will help limit the damage. In the emerging world, growth is expected to remain stable in 2023. In 2024, we anticipate a recovery in the US while the Eurozone could be stuck in a muddle-through scenario because of the energy stop-and-go.

#2. Cold Heart. The energy gap will continue to pose concerns in Europe. After record gas storage and energy efficiency gains helped avoid a blackout scenario in 2022, prospects for next winter (2023-2024) are limited as substitution of Russian gas imports will not suffice. Uncertain gas supply will create negative confidence effects and put the region’s fiscal capabilities to the test to cushion the impact of high electricity prices on firms and households. It will also compel policymakers to find ways to enhance energy efficiency and stabilize gas consumption beyond near-term savings, together. The alternative is a repeat of 2012 and a risk of fragmentation in Europe.

#3. Bad Blood. (Geo)politics made a bursting comeback to the forefront of concerns. From a split Congress and a noticeable return to good ‘ole protectionism through the Inflation Reduction Act (IRA) in the US, to Europe’s red herring policies to the negative competitiveness shock stemming from the energy crisis (sovereignty, re-industrialization), to China’s balancing act to exit zero-Covid, and the many important elections upcoming , investors and corporates will have to play coping strategies and buffers.

#4. Dragon Attack. The shift in China’s containment measures will alleviate pressures on slowing global trade, and accelerate the decline of producer prices. The domestic post-Covid rebound could start to be felt in the second half of 2023 and into 2024 as we expect sanitary restrictions to be eased in spring 2023. A faster easing would benefit the global economy while any setback could weigh on global trade and delay the easing of inflationary pressures.

#5. Never Give Up. Emerging markets will face very different challenges and headwinds in the coming months. Political risk has been rising in Latin America, Eastern European countries are being hit harder than most by the energy crisis and commodity importers throughout the world will have to cope with a strong dollar, and high energy and food prices. Credible policy moves will make the difference. Debt-sustainability concerns are increasing for some countries in a context of increasing rates and capital flight to safety.

#6. Castle on the Hill. Central bankers are determined to fight inflation and make sure that it does not remain entrenched. While the current hiking path is about to moderate, central banks’ independence will be tested either way: if erring on the side of keeping their monetary stance more restrictive for longer despite a looming recession, or if throwing in the towel to early and risking stagflation for good. Against the background of moderate quantitative tightening and decreasing system-wide liquidity, there is a risk of a squeeze from a policy mistake.

#7. Bad Habits. Since 2020, the war against the virus, and now against Russia, have had one super weapon: fiscal spending. It will remain at center stage over the next couple of years, from relief measures to the cost-of-living crisis, to green industrial policies to help with silent wars (climate change, aging), to fighting the urge towards a massive tax policy U-turn. More targeting for aid and fewer distortions are welcome to avoid financial markets becoming very selective.

#8. Easy on Me. In 2022, capital markets experienced an unmitigated disaster with an unprecedented price correction in both equities and fixed income. Going forward, earnings forecasts still seem too benign, and even a milder recession is not fully priced in. Fixed income is back but mind the risk. Also, as central banks drain excess system-wide liquidity and trading volumes decline even in historically liquid markets, watch out for financial accidents.

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