Recession over the next 12 months looks increasingly likely across developed markets, as tightening monetary conditions begin to put significant strains on financial systems.
Our outlook for 2023 focused on navigating the ‘polycrisis’ - a confluence of pressures which we believed could force central banks into overtightening and trigger sharp recessions.
That polycrisis has entered a new phase. While economies had started the year with signs of resilience, the fastest rate hiking episode in history is now taking its toll. Recession in developed markets looks the likeliest outcome. China may offer an alternative to developed markets - its reopening could yet provide respite to markets spanning East to West.
Three themes for Q2
Our Q2 Outlook highlights three key themes that we expect will dominate this quarter. You can watch Fidelity CIO, Andrew McCaffery, lay out each of these themes in the video below.
Hard vs. soft landing
In recent weeks, investors have gone further in pricing in sharp cuts in interest rates later this year but the US Federal Reserve (Fed) so far has stuck to its guns, worried that it must keep rates higher for longer in the face of persistently sticky inflation and hot labour markets.
Keeping rates higher for longer will increase the pressure on financial systems, and cracks are already starting to show. We do not believe that the collapse of Silicon Valley Bank, followed by Credit Suisse, is indicative of any systemic risk in the banking system, but it could be a sign of further upheaval still to come. New stresses will appear without an easing of monetary policy, which will give the Fed reason to revise its stance. A cyclical recession over a 12 month-time horizon, in which unemployment reaches 1-3 per cent, is still the most likely outcome, but a more severe recession would be on the cards were the Fed to remain restrictive throughout 2023.
Corporate risks and opportunities
In this higher-for-longer environment, our investment teams are focused on using their bottom-up research capabilities to identify names with resilient profiles. We’re looking for sectors and regions with structural tailwinds and defensive characteristics, along with attractive valuations, that present the best balance between risk and reward.
Over the longer-term, the themes of sustainability, demographics, and re-shoring/near-shoring continue to offer strong outperformance opportunities.
China reopening
If policy makers in the West are bracing for a hard landing, developments in China may offer a tonic.
Contrary to consensus, we saw October’s Communist Party Congress as a positive turning point. Since then, China’s leaders have emphasised high-quality growth, refocusing the economy from an investment, export-driven model to domestic consumption and manufacturing. Policymakers are likely to continue prioritising targeted easing to support some sectors, without any broad-based stimulus.
The result will be a different Chinese economy. The restructuring may lead to slower, but more sustainable, growth in the coming years.
