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Outlook 2023: Better Than Feared

As we look out to 2023, the U.S. Federal Reserve (Fed) has reached its “neutral” monetary policy stance, and the European Central Bank (ECB) is not…



As we look out to 2023, the U.S. Federal Reserve (Fed) has reached its “neutral” monetary policy stance, and the European Central Bank (ECB) is not far behind. Europe has moved fast to secure fossil fuel supply away from Russia, even at higher—but stable—prices. U.S. consumer price inflation is moderating. Asynchronous reopening, with China’s consumers set to rejoin the post-COVID economy, is likely to mean more inflation volatility next year.

Even so, if we can avoid geopolitical pressures escalating meaningfully from current levels (which are already uncomfortably high), can the world’s biggest demand centers pivot toward a multiyear cycle of modest but sustainable growth?

If so, equities may not be a bad place to be in 2023.

Slowflation—economic slowdown combined with rapidly rising inflation fueled by energy supply disruptions—proved a tough backdrop for financial markets in 2022. In the past two decades, only 2008 recorded worse returns for equities, while fixed-income investors have not had to contend with the likes of the year’s declines even in the depths of the Global Financial Crisis (GFC). On an absolute basis, both equities and fixed income were down about 14% to 18%.

The post-COVID economic transition back to something “more normal” proved volatile and is complicated further by rising geopolitical conflicts. None of the major economic powers have surpassed their pre-COVID output trajectories. The U.S. economy is the closest: by the end of the third quarter of 2022, its output was about 1.5% lower than it might have been in the absence of the pandemic. Euro area and Japanese output is more than 3.5% lower. And in larger EM economies, such as China, Brazil, and Indonesia, output ranges from about 5% to 7% lower.

Latest expectations, as embedded in consensus estimates, suggest that economic observers do not expect major economies to regain pre-COVID levels of output next year.

Energy Prices Should Ease

Open warfare between Russia and Ukraine amplified tensions between the world’s largest consumers of fossil fuel energy and its producers. Although the world has plenty of oil and gas, natural gas spot prices in Europe spiked to about seven times higher in 2022 compared to just one year prior. No economy can adjust to a cost shock of this magnitude in the space of a few quarters. Indeed, purchasing managers indices were already suggesting in the autumn of 2022 that the European economy is likely to enter a recession.

Today’s high prices may well lead to tomorrow’s low prices, and tomorrow may arrive sooner than many feared.

Although the outlook for fossil fuel energy supply in Europe remains unusually volatile, the risks are balanced. The Organization of the Petroleum Exporting Countries (OPEC) sought to limit crude supply by cutting daily production by 2 million barrels, just as Europe and the United States are implementing the next round of sanctions on Russian barrels (in part by barring Western firms from insuring Russian cargo).

Simultaneously, Germany has all but replaced importing capacity equivalent to its gas supply from the Nord Stream I pipeline. The government chartered five so-called floating storage and regasification units (FSRUs), which will be able to process 25 billion cubic meters of gas per year, roughly equivalent to half the capacity of the Nord Stream I pipeline. Meanwhile, the country’s first liquified natural gas (LNG) import terminal, in the port of Wilhelmshaven, is expected to be completed in early 2023—commissioned and built in less than a year.

A glut of LNG-carrying vessels destined for Europe, together with rapidly increasing capacity to process this supply, suggests that the meteoric rise of LNG prices and its dramatic drag on European inflation may be a story left in 2022. What is more, within a few years, Qatar and the United States should expand their respective LNG export capacity, and Europe should build enough proper import terminals. Today’s high prices may well lead to tomorrow’s low prices, and tomorrow may arrive sooner than many feared.

But Central Banks Can’t Wait

Yet the world’s leading central banks have signaled that they will not wait.

Perhaps one of the biggest surprises in 2022 was the speed with which the Fed moved its main policy rate toward a neutral stance. Assuming annual domestic inflation returns to a 2% to 3% range by the end of 2023, a neutral policy rate—where real rate is around 1.5%—is somewhere in the neighborhood of 3.5% to 4.5%. The federal funds rate—the Fed’s main policy instrument—currently stands at 4.50%. Further rate increases tilt the U.S. monetary-policy stance toward restrictive. 

Asynchronous reopening is set to bedevil the global economy for at least another year.

When the Fed intends to stop lifting its benchmark rate is a matter of not only domestic economic concern. Rapidly rising interest rates impact global liquidity conditions. We have already seen macroeconomic stress in Sri Lanka, a near credit event of sorts in the United Kingdom, and a blowup in the cryptocurrency markets.

So far, these stresses have not spilled into broader markets, but interest-rate increases impact financial conditions non-linearly. Debt payments of all sorts, and especially housing payments the world over, are linked directly to prevailing interest rates; when these rise rapidly, the possibility of financial and economic stress rises, too.

2023 Growth Depends on Inflation

Asynchronous reopening is set to bedevil the global economy for at least another year. We believe economic growth in the United States and Europe will depend largely on how quickly inflation abates.

This, in turn, depends on when and how China reopens its economy. A full or significant reopening in China is likely to impact tourism flows in Asia and further afield, especially in Europe and North America. This should buoy local domestic demand and may fuel services-related inflation in the affected jurisdictions. It should also support current accounts and local currencies from Thailand and Japan all the way to Europe.

China’s reopening is likely to make inflation readings in the United States and Europe more volatile and thereby complicate the Fed’s job of cooling domestic demand. In the absence of Chinese consumers, there are mounting reasons to believe that annual inflation of 3% toward the end of next year is attainable. Since the second half of 2022, housing and rental prices, continued improvement in supply chains, and domestic wage gains all point to accelerating moderation in annual inflation.

Let’s start with housing. The price of shelter accounts for nearly 40% of the Consumer Price Index (CPI); it is thus the single biggest—and stickiest—component of the U.S. basket of prices used to calculate national inflation. As 30-year fixed-rate mortgage rates passed 5% and then 6%, housing activity decelerated precipitously: sales of new builds are at the 2017-2019 average, while sales of existing homes are at decade lows and still falling.

Where transactions lead, prices follow: annual housing price inflation peaked in May 2022 and has been falling consistently since then. Private-sector measures of rentals point to outright price declines in the monthly data. Shelter inflation is notoriously difficult to convert into monthly CPI estimates, and we believe it will remain a drag on overall inflation for months to come, but broad housing market activity during much of 2022 suggests that we will see well-behaved shelter prices before the end of 2023.

Broad housing market activity during much of 2022 suggests that we will see well-behaved shelter prices before the end of 2023.

Goods prices reversed two decades of outright declines and grew strongly in the pandemic years. Supply-chain disruption proved difficult to remedy quickly, but as we enter 2023, spot price of a typical 40-foot shipping container is down some 80% from peak, purchasing manager surveys point to input price normalization, and suppliers’ delivery times are within reach of 2018-2019 averages. Annual goods price inflation peaked last February and has been declining steadily ever since.

Lower-value-add, high-touch services do not see much in the way of productivity gains. It is difficult—and maybe even undesirable—to increase the speed of a haircut or improve the efficiency of waitstaff beyond a certain point. For this reason, the Fed worries about wage inflation in services feeding directly into consumer price inflation. Yet, in the second half of 2022, services wage gains have decelerated from four-decade highs.

So, if the Fed reaches its neutral monetary policy stance and the ECB is not far behind; if fossil fuel supply away from Russia is secured, even at higher (but stable) prices; if consumer price inflation is moderating fast and the Fed does not overtighten into a major credit event somewhere; and crucially, if geopolitical pressures do not escalate meaningfully from their current uncomfortably high levels—then the world’s biggest demand centers may be able to pivot toward modest growth.

If so, risk assets may not be a bad place to be in 2023.

Olga Bitel, partner, is a global strategist on William Blair’s Global Equity team.

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Emerging Markets 2023 Outlook Series
Part 1 | Outlook 2023: Better Than Feared
Part 2 | Emerging Markets Equities: Positioned for a Rebound?
Part 3 | Emerging Markets Debt: Clearer Skies Ahead?
Part 4 | China: Zero-COVID Remains Key Growth Variable

The post Outlook 2023: Better Than Feared appeared first on William Blair.

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Lower mortgage rates fueling existing home sales

To understand why we had such a beat in sales, you only need to go back to Nov. 9, when mortgage rates started to fall from 7.37% to 5.99%.



Existing home sales had a huge beat of estimates on Tuesday. This wasn’t shocking for people who follow how I track housing data. To understand why we had such a beat in sales, you only need to go back to Nov. 9, when mortgage rates started to fall from 7.37% to 5.99%.

During November, December and January, purchase application data trended positive, meaning we had many weeks of better-looking data. The weekly growth in purchase application data during those months stabilized housing sales to a historically low level.

For many years I have talked about how rare it is that existing home sales trend below 4 million. That is why the historic collapse in demand in 2022 was one for the record books. We understood why sales collapsed during COVID-19. However, that was primarily due to behavior changes, which meant sales were poised to return higher once behavior returned to normal.

In 2022, it was all about affordability as mortgage rates had a historical rise. Many people just didn’t want to sell their homes and move with a much higher total cost for housing, while first-time homebuyers had to deal with affordability issues.

Even though mortgage rates were falling in November and December, positive purchase application data takes 30-90 days to hit the sales data. So, as sales collapsed from 6.5 million to 4 million in the monthly sales data, it set a low bar for sales to grow. This is something I talked about yesterday on CNBC, to take this home sale in context to what happened before it. 

Because housing data and all economics are so violent lately, we created the weekly Housing Market Tracker, which is designed to look forward, not backward.

From NAR: Total existing-home sales – completed transactions that include single-family homes, townhomes, condominiums and co-ops – vaulted 14.5% from January to a seasonally adjusted annual rate of 4.58 million in February. Year-over-year, sales fell 22.6% (down from 5.92 million in February 2022).

As we can see in the chart above, the bounce is very noticeable, but this is different than the COVID-19 lows and massive rebound in sales. Mortgage rates spiked from 5.99% to 7.10% this year, and that produced one month of negative forward-looking purchase application data, which takes about 30-90 days to hit the sales data.

So this report is too old and slow, but if you follow the tracker, you’re not slow. This is the wild housing action I have talked about for some time and why the Housing Market Tracker becomes helpful in understanding this data.

The last two weeks have had positive purchase application data as mortgage rates fell from 7.10% down to 6.55%; tomorrow, we will see if we can make a third positive week. One thing to remember about purchase application data since Nov. 9, 2022 is that it’s had a lot more positive data than harmful data. 

However, the one-month decline in purchase application data did bring us back to levels last seen in 1995 recently. So, the bar is so low we can trip over.

One of the reasons I took off the savagely unhealthy housing market label was that the days on the market are now above 30 days. I am not endorsing, nor will I ever, a housing market that has days on the market at teenager levels. A teenager level means one of two bad things are happening:

1. We have a massive credit boom in housing which will blow up in time because demand is booming, similar to the run-up in the housing bubble years.

2. We simply don’t have enough products for homebuyers, creating forced bidding in a low-inventory environment. 

Guess which one we had post 2020? Look at the purchase application data above — we never had a credit boom. Look at the Inventory data below. Even with the collapse in home sales and the first real rebound, total active listings are still below 1 million.

From NAR: Total housing inventory registered at the end of February was 980,000 units, identical to January & up 15.3% from one year ago (850,000). Unsold inventory sits at a 2.6-month supply at the current sales pace, down 10.3% from January but up from 1.7 months in February ’22. #NAREHS

However, with that said, the one data line that I love, love, love, the days on the market, is over 30 days again, and no longer a teenager like last year, when the housing market was savagely unhealthy.

From NAR: First-time buyers were responsible for 27% of sales in January; Individual investors purchased 18% of homes; All-cash sales accounted for 28% of transactions; Distressed sales represented 2% of sales; Properties typically remained on the market for 34 days.

Today’s existing home sales report was good: we saw a bounce in sales, as to be expected, and the days on the market are still over 30 days. When the Federal Reserve talks about a housing reset, they’re saying they did not like the bidding wars they saw last year, so the fact that price growth looks nothing like it was a year ago is a good thing.

Also, the days on market are on a level they might feel more comfortable in. And, in this report, we saw no signs of forced selling. I’ve always believed we would never see the forced selling we saw from 2005-2008, which was the worst part of the housing bubble crash years. The Federal Reserve also believes this to be the case because of the better credit standards we have in place since 2010. 

Case in point, the MBA‘s recent forbearance data shows that instead of forbearance skyrocketing higher, it’s collapsed. Remember, if you see a forbearance crash bro, hug them, they need it.

Today’s existing home sales report is backward looking as purchase application data did take a hit this year when mortgage rates spiked up to 7.10%. We all can agree now that even with a massive collapse in sales, the inventory data didn’t explode higher like many have predicted for over a decade now.

I have stressed that to understand the housing market, you need to understand how credit channels work post-2010. The 2005 bankruptcy reform laws and 2010 QM laws changed the landscape for housing economics in a way that even today I don’t believe people understand.

However, the housing market took its biggest shot ever in terms of affordability in 2022 and so far in 2023, and the American homeowner didn’t panic once. Even though this data is old, it shows the solid footing homeowners in America have, and how badly wrong the extremely bearish people in this country were about the state of the financial condition of the American homeowner.

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SVB contagion: Australia purportedly asks banks to report on crypto

Australia’s prudential regulator has purportedly told banks to improve reporting on crypto assets and provide daily updates.



Australia’s prudential regulator has purportedly told banks to improve reporting on crypto assets and provide daily updates.

Australia’s prudential regulator has purportedly asked local banks to report on cryptocurrency transactions amid the ongoing contagion of Silicon Valley Bank’s (SVB) collapse.

The Australian Prudential Regulation Authority (APRA) has started requesting banks to declare their exposures to startups and crypto-related companies, the Australian Financial Review reported on March 21.

The regulator has ordered banks to improve their reporting on crypto assets and provide daily updates to the APRA, the Financial Review notes, citing three people familiar with the matter. The agency is aiming to obtain more information and insight into banking exposures into crypto as well as associated risks, the sources said.

The new measures are apparently part of the APRA’s increased supervision of the banking sector in the aftermath of recent massive collapses in the global banking system. On March 19, UBS Group agreed to buy its ailing competitor Credit Suisse for $3.2 billion after the latter collapsed over the weekend. The takeover became one of the latest failures in the banking industry following the collapses of SVB and Silvergate.

Barrenjoey analyst Jonathan Mott reportedly told clients in a note that the situation “remains stable” for Australian banks but warned confidence could be quickly disrupted, putting pressure on bank margins.

Related: Silvergate, SBV collapse ‘definitely good’ for Bitcoin, Trezor exec says

“Our channel checks indicate deposits are not being withdrawn from smaller institutions in any size, and capital and liquidity buffers are strong,” Mott said, adding:

“But this is a crisis of confidence and credit spreads and cost of capital will continue to rise. At a minimum, this will add to the margin pressure the banks are facing, while credit quality will continue to deteriorate.”

The news comes soon after the Australian Banking Association launched a cost of living inquiry to study the impact of the COVID-19 pandemic and geopolitical tensions on Australians. The inquiry followed an analysis of the rising inflation suggesting that more than 186 banks in the United States are at risk of a similar shutdown if depositors decide to withdraw all funds.

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Delta Move Is Bad News For Southwest, United Airlines Passengers

Passengers won’t be happy about this, but there’s nothing they can do about it.



Passengers won't be happy about this, but there's nothing they can do about it.

Airfare prices move up and down based on two major things -- passenger demand and the cost of actually flying the plane. In recent months, with covid rules and mask mandates a thing of the past, demand has been very heavy.

Domestic air travel traffic for 2022 rose 10.9% compared to the prior year. The nation's air traffic in 2022 was at 79.6% of the full-year 2019 level. December 2022 domestic traffic was up 2.6% over the year-earlier period and was at 79.9% of December 2019 traffic, according to The International Air Transport Association (IATA).

“The industry left 2022 in far stronger shape than it entered, as most governments lifted COVID-19 travel restrictions during the year and people took advantage of the restoration of their freedom to travel. This momentum is expected to continue in the New Year,” said IATA Director General Willie Walsh.

And, while that's not a full recovery to 2019 levels, overall capacity has also not recovered. Total airline seats available actually sits "around 18% below the 2019 level," according to a report from industry analyst OAG.

So, basically, the drop in passengers equals the drop in capacity meaning that planes are flying full. That's one half of the equation that keeps airfare prices high and the second one looks bad for anyone planning to fly in the coming years.

Image source: Getty Images.

Airlines Face One Key Rising Cost

While airlines face some variable costs like fuel, they also must account for fixed costs when setting airfares. Personnel are a major piece of that and the pandemic has accelerated a pilot shortage. That has given the unions that represent pilots the upper hand when it comes to making deals with the airlines.

The first domino in that process fell when Delta Airlines (DAL) - Get Free Report pilots agreed to a contract in early March that gave them an immediate 18% increase with a total of a 34% raise over the four-year term of the deal.

"The Delta contract is now the industry standard, and we expect United to also offer their pilots a similar contract," investment analyst Helane Becker of Cowen wrote in a March 10 commentary, Travel Weekly reported.

US airfare prices have been climbing. They were 8.3% above pre-pandemic levels in February, according to Consumer Price Index, but they're actually below historical highs.

Southwest and United Airlines Pilots Are Next

Airlines have very little negotiating power when it comes to pilots. You can't fly a plane without pilots and the overall shortage of qualified people to fill those roles means that, within reason, United (UAL) - Get Free Report and Southwest Airlines  (LUV) - Get Free Report, both of which are negotiating new deals with their pilot unions, more or less have to equal (or improve on) the Delta deal.

The actual specifics don't matter much to consumers, but the takeaway is that the cost of hiring pilots is about to go up in a very meaningful way at both United and Southwest. That will create a situation where all major U.S. airlines have a higher cost basis going forward.

Lower fuel prices could offset that somewhat, but raises are not going to be unique to pilots. Southwest also has to make a deal with its flight attendants and, although they don't have the same leverage as the pilots, they have taken a hard line.   

The union, which represents Southwest’s 18,000 flight attendants, has been working without a contract for four years. It shared a statement on its Facebook page detailing its position Feb. 20.

"TWU Local 556 believes strongly in making this airline successful and is working to ensure this company we love isn’t run into the ground by leadership more concerned about shareholders than about workers and customers. Management’s methodology of choosing profits at the expense of the operation and its workforce has to change, because the flying public is also tired of the empty apologies that flight attendants have endured for years."

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