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Manulife InvestChoice – 2022 Q3 Market Outlook

July 2022

Quarterly Macro Outlook

The question many investors are asking is whether the worst start for global markets in decades is behind us. Yet, as we enter the final half of 2022, the macroeconomic outlook remains extremely challenging, characterized by high inflation, weaker economic growth, and tighter financial conditions. While our base case is that inflation will ease into 2023, at this point in time, we find ourselves preoccupied with emerging risks to that view.

In H2 2022, we expect to see a recession in the euro area, a weaker-than-expected economic recovery in China, and a material economic slowdown in the United States (a recession in early 2023 seems likely at this point). In this edition of Global Macro Outlook, we'll find out how shifts in the macro backdrop could affect the global economy and where resilience can be found, key highlights are:

 

Hawkish central banks

The U.S. Federal Reserve (Fed) and the Bank of England, among others, have indirectly indicated that they will knowingly hike into a material growth slowdown to tamp down inflation. This will have an important negative impact on global growth.

 

Inflation: sticky food and energy prices

Even as COVID-19-related supply chain issues ease and higher interest rates begin to curb consumer spending, the surge in energy and fertilizer prices points to intensifying food price inflation ahead.

 

Little reprieve for emerging economies

The top three destinations for emerging-market (EM) exports—China, Europe, and the United States—are likely to experience a significant slowdown in growth. Demand for their products are likely to ebb, compounding the pressures of capital outflow.

 

The end of central bank puts?

Since the global financial crisis, markets have come to expect the Fed (and/or other central banks) to step in to limit declines in asset prices beyond a certain threshold. A rethink, we believe, is required.

 

US: We think most risks are weighted to the downside going into latter half 2022 and into the first few quarters of 2023

Concerns about supply shortages in everything ranging from housing to goods and labor have been compounded by rapidly tightening financial conditions as the Fed continues to try to rein in stubbornly high inflation. It remains unclear how effective tighter monetary policy will be in dampening conflict-driven food and energy inflation, two areas that are taking up a larger portion of the consumer’s wallet.

 

At this stage, we think most risks are weighted to the downside going into the latter half of the year and into the first few quarters of 2023. In addition to inflation, sharply higher interest rates have already translated into slower housing activity, and we would expect this to migrate into broader interest-rate-sensitive goods in which inventories look to have accumulated.

Asia: We expect central banks to prioritize tackling inflation while the ultimate magnitude of tightening cycles will likely be relatively muted

Most economies reported an expansion in Q1 GDP thanks to a relaxation in domestic restrictions and the reopening of international borders. Over the past quarter, central banks in the region have all surprised the market with their hawkishness; however, the policy trade-off between slowing growth and higher inflation will likely grow starker. In our view, Asia’s recovery from the pandemic is still incomplete. That said, external demand has peaked, and higher commodity prices will hurt consumers’ purchasing power as tighter global financial conditions conspire to hold back the recovery even further. Meanwhile, the path toward fiscal support/consolidation looks challenging. Government finances were hit materially during the pandemic and are again under pressure amid policies introduced to cushion households from the surging cost of living (in the form of subsidies, price caps, tax cuts, cash transfers, etc.) and the evolving geopolitical climate (higher defense spending). We expect central banks to prioritize tackling inflation, but with broad price pressures in the region more benign versus the rest of the world, the ultimate magnitude of tightening cycles will likely be relatively muted.

Europe: Medium-term risks remain elevated as uncertainties around energy security have yet to be resolved, leaving Europe vulnerable to a continued rise in energy prices

Our base case is that the euro area will slip into a recession in 2022 on the back of the large spillovers from, most notably, Russia’s invasion of Ukraine; the negative terms of trade shock in food and energy, and the supply shortage of these key resources. The squeeze on household disposable income will likely weigh on consumption, and rising input costs will be a drag on private investment. Rising inflation has forced the ECB to normalize monetary policy amid economic weakness (like most central banks), albeit in a manner that’s becoming severely disruptive for the currency bloc. Collateral damage can be observed in the sovereign bond market, with peripheral yield spreads widening in a manner that complicates the ECB’s policy transmission. Medium-term risks remain elevated as uncertainties around energy security have yet to be resolved, leaving Europe vulnerable to a continued rise in energy prices. Political risks remain prominent, highlighted by the surprise outcome of the French legislative election in June and opinion polls in Italy, which revealed a shift toward far-right parties ahead of the next general election scheduled for mid-2023.

Disclaimer – Quarterly Macro Outlook

Manulife Investment Management is the global wealth and asset management segment of Manulife Financial Corporation. The information and/or analysis contained in this material have been compiled or arrived at from sources believed to be reliable but Manulife Investment Management does not make any representation as to their accuracy, correctness, usefulness or completeness and does not accept liability for any loss arising from the use hereof or the information and/or analysis contained herein. Neither Manulife Investment Management or its affiliates, nor any of their directors, officers or employees shall assume any liability or responsibility for any direct or indirect loss or damage or any other consequence of any person acting or not acting in reliance on the information contained herein.

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