Looking back at the end of last year, Wall Street wrote its outlook for 2023 with anticipation, with a US recession certain, global central banks shifting to interest rate cuts, and geopolitical conflicts changing assets......
Now, most of the expectations have not been realized, the US GDP in the third quarter was 4.9%, and the European and American central banks did not cut interest rates, and the conflict did not have a significant impact on the market......
To be sure, this is not uncommon, and Wall Street has historically been inaccurate about what will happen at a turning point. But according to a report released on Wednesday by macro research firm TSLombard, none of Wall Street's top 10 predictions for 2023 came true.
While accurate predictions are important, Xi lessons are equally important, and here are the top 10 predictions that were "slapped in the face" by reality compiled by TSLombard:
100% recession in the U.S. economy? Reality: GDP 4.9% in the third quarter
As interest rates rise, it can be said that economic growth is slowing down, but in 2023, the US economy has stepped out of the "anti-common sense" trend, with GDP growth of 4.9% in the third quarter of the highest interest rate in 22 years.
At the end of last year, as the Fed raised interest rates by 425 basis points a year, real interest rates entered restrictive territory, and the U.S. Treasury yield curve continued to invert, the market consensus was that the probability of a recession was as high as 70%. Bloomberg's economic model predicts that a recession in the United States is almost a certainty. After that, the voice of a recession in the United States has become louder, and the probability of a recession prediction has become higher and higher.
However, the U.S. economy has been more resilient to rate hikes than consensus expected. Not only is there no recession, but US GDP growth reached 4.9% in the third quarter of 2023, and in January, almost no one predicted such a high rate of GDP growth. Now that the sound of recession is slowly drowned, the call for a "soft landing" of the U.S. economy is gradually rising, and the market expects that the U.S. economic growth will slow down in 2024, but the "soft landing" is still the basic scenario prediction.
Why is there no recession in the United States? The analysis points out that this is related to the long duration of the US debt, as well as the large amount of fiscal stimulus and the high level of net wealth associated with it.
First, borrowers don't have to start paying higher interest rates yet, they've locked in the lower interest rates they had before. Second, in a year of low unemployment, the U.S. government printed money like crazy and the fiscal deficit soared, while U.S. consumers still had excess savings. The San Francisco Fed originally believed that consumers would run out of excess savings in the third quarter of this year, but then revised it in November and projected that there would still be $430 billion in excess savings that would not be used up until the first half of 2024.
Moreover, from a psychological point of view, one reason people are wrong is that people inevitably tend to predict the future based on current trends, which has proven to be especially unreliable in the bizarre post-pandemic environment. As you can see in this chart released at the beginning of the year, this is a type A recovery, with a big rally and then a rapid decline. This tells us that the pandemic means that this is not a "normal" economic cycle and that trends cannot be simply extrapolated.
"Falling inflation" is not accompanied by "rising unemployment"
Most people take it for granted that to bring inflation down, the economy must slow down and unemployment must rise accordingly.
However, there has been no side effect of cooling inflation in this "abnormal" cycle: monetary tightening has reduced the number of job openings without leaving people out of work, demand has supported the sectors where shortages are most pronounced, and at the same time the labor force participation rate has risen.
There seems to be no precedent before, but TSLombard analyst Dario Perkins pointed out in March that the years after World War II were instructive, when reconstruction drove inflation up first and then down, but unemployment did not rise significantly.
The post-World War II period confirms the possibility of a "perfect inflation cooling", but it also reminds us that not everything can go back to where it was in 2019. Amid the distortions caused by the pandemic and geopolitical conflicts, structural changes have been slowly occurring that will last for years, including labor shortages, deglobalization, and changing geopolitics.
The global "wave of interest rate cuts" has not come, and neither Europe nor the United States has fallen
The previous widespread prediction of a "recession" also means another thing, 2023 is the year of major central banks pivoting and cutting interest rates.
At the beginning of the year, markets priced in aggressive rate cuts in 2023, but for the most part, the resilience of the economy has made major central banks more hawkish than the market initially expected. The Fed itself peaked at 5.5% versus the 5% expected for 2022, while the ECB reached 4% versus 3% expected.
The surprise was far from what was expected, prompting a sharp shift in the "pivot" of the Fed's monetary policy expectations, with high interest rates leading to market expectations of a more aggressive Fed rate cut, with five rate hikes expected to be five in six months.
The market is pricing in the Bank of England's peak interest rate of 6.5%!
Remember Britain's shortest-lived Prime Minister Liz Truss, whose proposed "mini-budget" (tax cuts when inflation soars) bill hit global financial markets, and the interest rate market quickly adjusted its assessment and predicted that the Bank of England's peak interest rate would reach 6.5%.
However, with a new prime minister in office and a more rational fiscal plan, this expectation fell back to 4.7% in early 2023, and the Bank of England finally left interest rates unchanged at 5.25% for three consecutive times.
The reason for this flurry of changes is that Perkins noted in the report that as we entered the summer, the market reassessed, predicting that the first period of the rise was driven by an unexpected upside in UK economic growth, followed by an unexpected rise in inflation and a reassessment of term premiums. Since the Bank of England has already started tightening policy at the end of 2021, and most mortgages in the UK have a maturity of 2-5 years, sooner or later tightening will play a role in the economy.
It is worth mentioning that the UK has long been the most inflationary of the advanced economies. UK inflation rose to a 41-year high of 11% at the end of last year, but then fell at an unexpectedly rapid pace, with CPI falling to 3.9% year-on-year in November.
The Bank of Japan has taken a deep breath and has not yet ended negative interest rates
As inflation continues to rise in Japan, the market is expecting Japan to end its "negative interest rate policy" at the end of 2022 and expects a 30 basis point rate hike in 2023.
Over the past year, markets have tested the BoJ's dovish resolve, with the yen falling to multi-decade lows and the resurgence of the "widow's trade", pushing Japanese bond yields above the upper limit of the target.
However, the Bank of Japan held its breath and remained negative in its last interest rate decision of the year.
The Bank of Japan (BOJ) has been slow to act, giving the official explanation that the Japanese economy is in the early stages of recovery, and economic and price uncertainty remains high, but it still needs to be carefully examined whether there will be an active wage inflation cycle.
The Silicon Valley Bank crisis did not erupt in full
The collapse of Silicon Valley Bank in March was one of the bumpy roads to higher policy rates after more than a decade of low interest rates and quantitative easing, raising widespread concerns about regional bank liquidity and the end of century-old financial giant Credit Suisse shortly thereafter.
The rise in long-term Treasury yields at the beginning of the year put significant pressure on banks that were taking on too much maturity risk, with many small and medium-sized US banks holding too much long-term bonds, heavily affected by interest rate movements. These financial institutions also have to face the problem of an inverted yield curve, and when long-term interest rates are lower than short-term interest rates, the traditional business model of commercial banks for short-term loans and long-term loans will become invalid.
Immediately after the rise in 10-year Treasury yields in March, news of the collapse of several regional banks, led by Silicon Valley Bank, made a full-blown crisis seem inevitable, with Credit Suisse, one of the world's most systemically important banks, selling to rival UBS, a snap that deepened expectations of a full-blown crisis.
However, the banking sector appears to have survived, with analysis citing higher credit from bank customers, rising interest rates not leading to the expected wave of defaults, and the fact that banks are getting liquidity from the Federal Reserve. Global liquidity turned around in October 2022 even as the official target rate rose, and global central banks decided not to allow a repeat of the UK gilt crisis, which proved to have a bigger impact on bank term loans issued by the FDIC, the Treasury and the Federal Reserve.
Perkins said that the crisis at the time was not expected to erupt in full force due to the self-correcting nature of the crisis caused by rising interest rates and the swift response of the authorities, but the impact of the crisis was even smaller than initially predicted, and the tightening of credit conditions did not squeeze economic growth as expected.
$30 trillion in debt The U.S. government has not defaulted
Against the backdrop of increasingly polarized U.S. politics, markets became restless in the second quarter, with the old problem of U.S. government defaults re-enacted.
Since May, the Biden administration and the Federal Reserve have issued a series of debt default warnings, and the US government's debt has exceeded $31.4 trillion, in June, the US debt ceiling agreement was reached to suspend the debt ceiling until early 2025, and a few months later, Fitch downgraded the US debt rating from AAA to AA+, citing the growing debt burden and the repeated impasse over the debt ceiling.
While the U.S. government almost always agrees at the last minute when it nears the debt ceiling, it also serves as a reminder to investors about the U.S. government's structural problems.
Under high interest rates, the global real estate market is holding
Commercial real estate has been in a terrible situation during the pandemic, especially shopping malls or office buildings, and high interest rates have further exacerbated the pressure.
Historically, the 10-year yield has been an inverse indicator of real estate: global real estate stocks fell sharply as bond yields soared in October. Since then, property stocks have started to recover, up about 10% for the year.
There are six reasons for the resilience of the global real estate market: 1) expectations of imminent interest rate cuts, 2) seller "strikes" (the result of interest rate "lock-in" and homeowner psychology), 3) various extensions and programs, especially in the riskiest markets (such as Canada), 4) monetary illusion (falling real rather than nominal prices), 5) structural demand support (remote work and immigration), and 6) continued strength in the labor market.
But it's too early to tell, and it's possible that the commercial real estate crisis is coming late. If a crisis occurs, it could cause the central bank to pivot ahead and bail out real estate with lower long-term interest rates.
Geopolitical conflicts have not had a significant impact on the market
The past year has seen the specter of geopolitical conflicts loom over, and markets continue to move forward amid the tail-facing risks of these conflicts.
The outbreak of the Russia-Ukraine conflict in 2022 caused a huge shock to financial markets and the economy, but in the same year it was adjusted, the supply chain crisis eased, and energy prices fell.
In October 2023, the conflict between Israel and Hamas threatened oil supplies and surged energy prices, but crude oil prices then erased gains since the conflict.
While European gas prices remain lower than they were a year ago, the expected full-blown humanitarian crisis due to the gas surge has not happened, with Europe's main benchmark gas prices falling by 50%.
Overall, the geopolitical conflicts of recent years have not had a significant impact on the economy or markets, and the chart below shows the geopolitical risks in different countries. What can be seen is that for the United States, all the events that preceded and followed 9/11 were overshadowed. The biggest event for Germany is the Russia-Ukraine conflict, which is seen as a transformative moment, after Germany was extremely dependent on Russian energy.
Our ability to adapt to conflict has proven to be much greater than expected, which has helped to avoid the expected recession. However, in 2024, the conflict will continue, and more importantly, the global market will usher in greater variability, with nearly half of the world's countries facing elections next year. The lesson in geopolitics in 2023 is that markets can "turn a blind eye" to conflict, so will that apply in 2024?
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