The first quarter of 2023 began with positive sentiment on the growth outlook, as energy costs fell and China’s economy showed tentative signs of reopening. However, the mid-March collapse of Silicon Valley Bank (SVB) and Credit Suisse (CS) served as a sharp reminder that tighter financial conditions and slower growth can be a dangerous combination, and investors should not become complacent.

Throughout this period, central banks continued to hike interest rates, although some altered their stance. The Federal Reserve (Fed) announced two rate hikes of 25 basis points (bps) each, while the European Central Bank (ECB) remained more hawkish, raising rates twice in 50bps increments. The Bank of England (BoE) implemented two rate hikes of 50bps and 25bps.

In Q1, growth expectations improved somewhat as headline inflation began to recede. However, the full impact of tighter financial conditions has yet to be fully felt by consumers, although there are indications that hiking cycles were already biting, particularly in the housing markets.

Our baseline macro scenario is one where higher rates cool global demand and bring inflation back under control. However, the slow decline in inflation means that central banks cannot wait to assess the impact of their policies on growth. As a result, the Fed Funds Rate may peak at 5% and hold there for a longer duration than expected until inflation convincingly heads lower. Under these conditions, growth may suffer, but it is unlikely to collapse.

Conditions in Western economies remain tight, and the longer they persist, the stronger the gravitational pull towards inflation. Hence, it is probable that peak inflation is behind us. However, several long-term constraints are keeping the new regime in place and inflation above pre-pandemic levels. These include geopolitical fragmentation, inshoring as multinationals focus on the resilience of the supply chain, the transition to a lower-carbon world, and populist measures aimed at supporting disenfranchised middle classes in the West.

To read the full AndPapers Q2 2023 click here.

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