BNP Paribas Markets 360 analysts expect stronger growth to result in more persistent inflation that central banks will have to work even harder to contain.
Although we have revised up our forecasts reflecting resilience in the global economy around the turn of the year, our fundamental view has not changed: central banks need to create sufficient slack in the economy in order to bring inflation sustainably back to target. Our new outlook sees even higher rates persisting for longer, and as a result a recession in the US has merely been delayed, not dodged altogether.
Luigi Speranza, Head of Markets 360 and Chief Economist
Upward revision in economic activity forecasts to reflect unexpected global resilience
Growth has proved stronger than Markets 360 analysts anticipated in their November Global Outlook, underpinned by three main factors:
- Lower energy prices: This has been a particularly important factor for Europe, which looks to have escaped an energy-driven recession this winter thanks to unseasonably warm weather and a diversification of gas sources away from Russia. However, still-high prices mean the region continues to face a structural energy challenge in the medium term.
- Post-Covid China: China’s reopening was more abrupt and decisive than Markets 360 experts had anticipated, and they have revised up their 2023 growth forecast for China to 5.6%, expecting positive spillovers to the rest of the global economy.
- Buffers: Headwinds from monetary policy have been mitigated by significant tailwinds, including household savings accumulated during the pandemic, persistently supportive fiscal policy and labour hoarding.
However, despite an improved growth backdrop, the fundamental story has not changed: bringing inflation back to target on a sustainable basis requires a material degree of slack in the economy. A key consequence of the improved growth outlook therefore, is that inflation is likely to prove more persistent than the headline declines from the peak led the markets to conclude at the turn of 2023, delaying the ongoing disinflationary process or at least making it bumpier.
Persistent inflation means central banks will have more to do
The analysts therefore believe the jobs of central banks remain unfinished, and have revised up their terminal rate forecasts for the US Federal Reserve (to 5.75% from 5.25% previously) and the European Central Bank (4.00% from 3.25% previously). They expect the Bank of Japan to raise its yield-curve-control band before removing it, and the People’s Bank of China to refrain from further cuts in its medium-term lending facility rate. Rate cuts are likely off the table for the rest of the year at least, with the exception of some emerging-market central banks.
The impact of policy tightening will weigh on the economy in time, the analysts believe, and as a result, the recession is merely delayed in the US rather than avoided, while in Europe they see a prolonged period of below-trend growth.
Emerging markets differentiation
Markets 360 analysts expect emerging Asian economies to outperform thanks to China’s reopening, and Latam economies to lag behind. Central and Eastern European central banks are likely to open the cutting cycle, although scope for emerging markets (EM) to lead developed markets (DM) will be more limited than on the way up.
Risks to the base case
The analysts see a high risk of a policy mistake, given the macroeconomic uncertainty, and note two major risks to their central scenario:
- Central banks do too little: Central banks might be more sensitive to the risks of over-tightening than the analysts assume, or inflation might prove stickier than in their base case, requiring a sharper adjustment down the line.
- Central banks do too much: Central banks might be forced by resilient growth or – worse – stickier-than-expected inflation to raise policy rates more than in the analysts’ base case. This could trigger a deeper downturn, in turn increasing the chances of rate cuts sooner than they currently pencil in.
Later peak in yields, weaker USD, stocks and credit
Markets 360 analysts have pushed back and raised their forecast peak in G10 bond yields to Q2 (from Q1), with a further sell-off in Europe likely to need a break higher in real yields. Into Q2 they see continued two-way risk, given the upside risk to central banks’ required action and low bond yields relative to policy rates.
The USD will be relatively supported as Fed expectations adjust higher, analysts believe, but a lower recession risk makes a good case for eventual USD weakness. They see downside risk for global equity markets – apart from emerging-market indices – in the months ahead, driven by earnings weakness.
They are bearish on credit, but not as much as in 2022, with the US most at risk of excessive policy tightening undermining credit fundamentals and resulting in a downgrade-and-default cycle.
Commodity upside
Markets 360 has a positive outlook for crude oil prices in H2 2023, with Chinese crude demand picking up against a relatively modest rise in US production. Similarly, they expect the global gas market to tighten by the year end, and see significant upside risk to European power prices.
Rise in green bond issuance
Markets 360 sustainability analysts forecast global green bond issuance to rise by at least 15%, with the risk to the upside, driven by higher funding needs in EMEA and APAC and better market access for corporate issuers.
While sustainability-linked bond issuance dipped in January 2023 compared with the same period in 2022, they expect them to remain an instrument of choice. Transition bond issuance, meanwhile, is likely to benefit from Japan’s planned issuance in the coming years.
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