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Text on screen: Tina Adatia, Fixed Income Strategist
Tina: Tiffany, if we start with our latest outlook titled Strained Market, Strong bonds, what were the prevalent themes that we can expect for next year?
Text on screen: Tiffany Wilding, Economist
Tiffany: So, we've seen one of the fastest accelerations in inflation in multi decades, to say the least. And of course, that's been met with one of the fastest pace of rate hikes through various developed markets, central banks that we've also seen in decades
And on our financial conditions index, we've actually seen a pace of tightening that's on par with the 2008 financial crisis. So, it has been quite notable this year now we don't think similar to the 2008 financial crisis, you're going to see a deep recession, but nevertheless, we do think modest recession in the outlook is still appropriate just given that level of policy response that we've seen.
FULL PAGE GRAPHIC: TITLE – Strained Markets, Strong Bonds: Investment implications. SUBTITLE – Our process helps us evaluate a range of scenarios to determine the most likely road ahead. The graphic shows three hexagons with bullets that connect to each other via arrows. The top hexagon reads Scenarios with the accompanying bullets: Soft landing, overheating, hard landing and stagflation. The middle hexagon reads 2023 DM Outlook with the accompanying bullets: Recession likely, Inflation moderating, Policy on hold. The bottom hexagon reads Investment Implications with the accompanying bullets: Bonds are back, Focus on resilience, Opportunities in active.
So the context of mild recessions across developed markets in tight financial conditions, we would really emphasize three themes. So, the first is that inflation is going to moderate very likely to moderate this year.
So, if you look at the composition of inflation again, across the developed market measures what you find is that energy prices, some of the goods inflation that we got that will fade away.
So, in the United States, for example, getting from 9% to where we peak down to 4%. That'll happen actually relatively quickly, but then going from 4% all the way back to 2%, that's going to take a little bit more time and that's because we've also seen unit labor costs and wage inflation accelerate, and that'll just take more time and more effort from central banks in terms of restrictive policy to moderate back.
The second theme we would just highlight though is that central banks have done a lot of the adjustment already, and we are closer to holding policy at restrictive levels as opposed to getting policy there.
And in fact, we think markets are actually largely priced for the additional rate hikes that we could see maybe over the next quarter.
But that the third theme that we would really focus on this year is that although that central bank adjustment may have largely occurred, the real economy adjustment is yet to occur.
And that's because monetary policy works through lags. So, you will see some pain, some real economic pain, especially in labor markets across developed markets because that will help to moderate inflation throughout the year.
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