House View
2023 Macro Outlook
Long-term structural challenges continue to weigh on the global economy.
Key takeaways
- Headline inflation and bond yields fell worldwide, while peak interest rate expectations softened.
- We no longer forecast a synchronized global recession.
- In the U.S., our recession forecast is downgraded to a technical recession starting in Q4 2023.
- In Europe, we forecast a modest winter recession followed by a recovery in summer 2023.
- China’s faster-than-expected reopening will boost global commodity demand and reignite energy inflation in H2 and may help the U.S. avoid recession entirely.
- In Japan, we expect modestly higher bond yields and inflation to ignite a long-awaited recovery for the deflation-mired economy.
- We have downgraded our expectations for further rate hikes but do not expect any central bank interest rate cuts until early 2024.
Lower near-term interest rates and inflation, but a higher structural trend
Central bankers continue to talk a tough line on inflation, but their published rate hike forecasts are then challenged by implied pricing in bond markets. For example, in the U.S., the Federal Reserve’s ‘Dot Plot’ has the Fed Funds Rate peaking at 5-5.25%, while markets are pricing in a terminal rate 25-basis-point lower. A salient focus for real assets investors is where the discrepancy in inflation expectations between bond markets and central banks finally converge.
- Following the anticipated 25-basis-point hike in February, we also expect another 25-basis-point hike in the next FOMC meeting on March 22. We believe the Fed will then hold through until 2024, when it can clearly see inflation falling below 5%.
- We also note the 50-basis-point rate hikes this month in the UK and Eurozone, with the terminal rate possibly reached as early as this quarter. Similar to the U.S., we expect the BOE and ECB to hold rates through the end of the year.
When will rates start to fall, and where will they normalize?
We are entering a new period of monetary policy where central banks seek to normalize their balance sheets and create a nominal interest rate buffer against the next downturn. Several structural tailwinds are now reversing, supporting trend inflation. These include:
- The move toward just-in-case inventory and diversifying supply chains raising the frictional cost of trade
- The demographic turning points in China and several European countries mean that labor scarcity and high labor costs are likely to persist
- In the U.S., labor scarcity being expected to continue unabated unless and until immigration normalizes to pre-Covid levels
- In Europe, where ESG regulation is the most embedded, expecting high costs of an at-pace energy transition over the medium-term, even if it results in lower long-run energy costs
- China’s faster-than-expected reopening boosting global commodity demand as the manufacturing sector ramps back up, triggering an upswing in energy prices in the second half of this year prompting us to raise our global energy price forecasts (see chart below).
Pathway to ending decades of Japanese deflation in sight
After the current credit cycle peak, we expect nominal interest rates and inflation to trend higher than before the pandemic. The big outlier is Japan, where the global inflationary surge looks to have finally lifted current and future inflation expectations. After years of aggressive Yield Curve Control (YCC) policy, the Bank of Japan (BOJ) has opened the door to widening their bond yield band, and markets are now pricing in modestly higher bond yields and inflation which is expected to herald in a long-awaited recovery for an economy mired in decades-long deflation.The BOJ is expected to see a new Governor in April, which makes monetary policy forecasting tricky. Notwithstanding, we expect the 50-basis-point band re-asserted and widened to 75 or 100 basis points, or the YCC policy abandoned. We now expect Japanese bond yields to rise to 75 basis points in 2023, then level out at 100 basis points thereafter, broadly in line with market-implied forecasts. Even with these actions,
Japan would still have the lowest inflation and lowest interest rate of any major market we invest.
Real interest rates eventually to run modestly positive
Investors’ attention to real interest rates reflects the nature of income generated in real assets, where income is often viewed as part way between nominal and real given the capacity to reset rents to market levels or to have explicit inflation-linked contracts. We expect real interest rates to run modestly positive once we get through the current correction. As the chart below shows, we expect real bond yields to settle back to c.1-1.5% in all markets except Japan, where they will remain negative.
Risks of a global recession recede
Our macro forecasts are now less pessimistic. We expect a delayed and softer U.S. recession, a softer European recession, and a stronger China rebound.
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Introduction
In my role as CBRE Investment Management’s Chief Economist, the question clients and colleagues alike ask me the most these days , is “how high will interest rates go?” It impacts every part of our lives from the denominator impact on capital flows into real estate, to capital market liquidity as debt-backed buyers retreat, to the cost of our own mortgages. To be sure, I’ll get into our revised forecasts for terminal rates in this new edition of Macro House View, but I’ll also argue that perhaps the more important question for real assets investors is where will interest rates, and inflation, settle once we’re through this economic and capital market correction?
Lower near-term interest rates and inflation but a higher structural trend
The good news is that since we last revisited our macro forecasts, the high-frequency data have been pretty encouraging. Thanks to an historically warm winter in Europe and lower energy usage from newly cost-conscious consumers, wholesale energy prices are falling sharply. In fact, Chart 1 shows that natural gas prices are now lower than they were before the Russian invasion of Ukraine, thanks to the rapid decline in energy price inflation as shown in Chart 2. The exception is the UK, where a combination of limited energy storage capability and a dependence on gas means that it’s particularly vulnerable to the ongoing supply disruption.
This means that as we begin 2023, we do so with lower current inflation and lower-than-previously-forecast current and forecast bond yields. In pretty much every market, barring Japan – more on that later – Chart 3 shows that nominal bond yields have come down markedly from their peak around November 2022. This is already having an impact on residential mortgage rates. It’s also setting up an interesting game of chicken between bond markets and central banks around the world. We are continually hearing central bankers take a tough line on inflation and publish rate hike forecasts that are then being challenged by bond market implied pricing.
For example, in the U.S., the Federal Reserve’s Dot Plot has the Fed Funds Rate peaking at 5-5.25%, but markets are pricing in a terminal rate 25 basis points lower, and Chart 4 shows that we have switched our forecast to that lower level too. That said, unlike markets, we believe the Fed will hold through until 2024 when it can clearly see inflation falling back below 5%. We also expect to see another 50 basis points of rate hikes in the UK and Eurozone, with the terminal rate being reached maybe as early as this quarter. And then, as in the U.S., rates will be on hold through to the end of the year.
With the terminal rate now in sight, the next question becomes more important: when will rates start to fall and where will they normalize? As we said in prior rounds of our macro forecasts, we do not think nominal rates (or inflation for that matter) will get back to where they were before the pandemic. That was an historically strange period of heavy central bank intervention where bond yields were deliberately held low to force investors into higher-yielding assets, not least of which was real estate. We were all the beneficiaries of incredibly low bond yields.
But it’s clear that we are now entering a new period of monetary policy where central banks seek to normalize their balance sheets and create some kind of nominal interest rate buffer against the next downturn. Moreover, a number of structural tailwinds are going into reverse when it comes to trend inflation. The move toward just-in-case inventory and diversifying supply chains raises the frictional cost of trade. The demographic turning points in China and several European countries mean that labor scarcity and high labor costs are likely to persist. And even in the more demographically blessed United States, labor scarcity continues to be an issue and is likely to remain so unless and until immigration normalizes to pre-Covid levels. Finally, and this is particularly acute in Europe where ESG regulation is the most embedded, we have to factor in the medium-term high costs of an at-pace energy transition even if, in the long-run, it results in lower energy costs.
Added to this, we now have to factor in the impact of a surprisingly quick reopening of the Chinese economy, reversing three years of Zero Covid policy that stymied manufacturing output, damaged global supply chains, and depressed domestic consumer sentiment. If the U.S. and European reopenings have taught us anything, it’s that when economies reopen, consumers go “revenge spending.” An added twist to the Chinese reopening is likely to be a boost to global commodity demand as the manufacturing sector ramps back up, triggering an upswing in energy prices in the second half of this year.
The faster-than-expected China reopening has driven us to raise our global energy price forecasts. Chart 5 shows that we now have a curious “M” shape to our oil price forecast, for example, with prices falling faster than we had expected over winter 2022/23, but then building up again in late 2023/24 as Chinese demand comes back online, before settling back at a modestly higher level than previously forecast.
So, the upshot is that even after the peak of this credit cycle, we expect nominal interest rates and inflation to trend higher than before the pandemic. But as Chart 6 shows, the big differential is in Japan, where the global inflationary surge looks like it has finally lifted both current and expected inflation. As a result, after years of aggressive Yield Curve Control policy, the Bank of Japan has opened the door to widening their bond yield band, and markets are now pricing in modestly higher bond yields and inflation. In the case of an economy which has been mired in deflation for decades, this is arguably a good thing and a sign of recovery.
Forecasting a change of monetary policy is particularly hard in Japan given that we are expecting a new Bank of Japan governor in April. We could have the 50-basis-point band reasserted, the band widened to 75 or 100 basis points, or YCC policy abandoned entirely. Accordingly, Chart 7 shows that we have chosen to take a median path through the potential forecast spectrum and are expecting Japanese bond yields to rise to 75 basis points in 2023, and then level out at 100 basis points thereafter, broadly in line with market implied forecasts. We acknowledge that this forecast is particularly fraught with uncertainty but take some comfort that even with bond yields at 1% for the first time since 2011, this would still leave Japan as the lowest inflation, lowest interest rate major market that we invest in.
A key point for real assets investors lies in our expectations for REAL interest rates because the income that we generate is often viewed as part way between nominal and real given our capacity to reset rents to market levels or to have contracts that are explicitly inflation-linked. As Chart 8 shows, we certainly expect real interest rates to run modestly positive once we get through the current correction. But this should be seen as a return to normal after a period of incredibly negative real rates. This is not atypical of the real bond yield environment that we saw in the immediate post-GFC period or in the mid-2000s – environments in which real assets were still seen as attractive.
Meanwhile, the faster-than-expected China reopening means that our forecasts for growth in the second half of this year have been revised up, with an impact in the latter years of the forecast period too. That said, on our forecasts, the fastest years of industrialization are over for China, and demographic factors are also weighing on medium-term growth, pinning it back to 5% y/y.
But the biggest change is arguably to our U.S. forecasts, where the ongoing strength of the labor market and strong consumer sentiment—despite housing market weakness—means that we have pushed back and softened our forecasts for a U.S. recession to a purely technical one starting in Q4. Thereafter, we forecast a strong recovery based on the assumption of ongoing labor market tightness and consumer strength. Accordingly, we are no longer forecasting a synchronized global recession. Indeed, it is highly likely that any U.S. recession will begin once Europe has started its recovery. Moreover, if anything, the China reopening bounce could, at the margin, help the U.S. avoid recession altogether, given its sheer economic size and importance to global trade.
Overall, the macro forecasts are now less pessimistic, with a softer European recession, delayed and softer U.S. recession and stronger China rebound. This is not to underplay the sizeable structural challenges facing the global economy: whether they be the overhang of government debt; demographic headwinds facing most markets ex-North America; or the cost of transitioning to lower carbon usage. However, the mix of modestly positive economic growth coupled with positive, but still fairly low, real interest rates, is a solid backdrop for real assets investors, once we have traversed the current correction.
This means that as we begin 2023, we do so with lower current inflation and lower-than-previously-forecast current and forecast bond yields. In pretty much every market, barring Japan – more on that later – Chart 3 shows that nominal bond yields have come down markedly from their peak around November 2022. This is already having an impact on residential mortgage rates. It’s also setting up an interesting game of chicken between bond markets and central banks around the world. We are continually hearing central bankers take a tough line on inflation and publish rate hike forecasts that are then being challenged by bond market implied pricing.
For example, in the U.S., the Federal Reserve’s Dot Plot has the Fed Funds Rate peaking at 5-5.25%, but markets are pricing in a terminal rate 25 basis points lower, and Chart 4 shows that we have switched our forecast to that lower level too. That said, unlike markets, we believe the Fed will hold through until 2024 when it can clearly see inflation falling back below 5%. We also expect to see another 50 basis points of rate hikes in the UK and Eurozone, with the terminal rate being reached maybe as early as this quarter. And then, as in the U.S., rates will be on hold through to the end of the year.
With the terminal rate now in sight, the next question becomes more important: when will rates start to fall and where will they normalize? As we said in prior rounds of our macro forecasts, we do not think nominal rates (or inflation for that matter) will get back to where they were before the pandemic. That was an historically strange period of heavy central bank intervention where bond yields were deliberately held low to force investors into higher-yielding assets, not least of which was real estate. We were all the beneficiaries of incredibly low bond yields.
But it’s clear that we are now entering a new period of monetary policy where central banks seek to normalize their balance sheets and create some kind of nominal interest rate buffer against the next downturn. Moreover, a number of structural tailwinds are going into reverse when it comes to trend inflation. The move toward just-in-case inventory and diversifying supply chains raises the frictional cost of trade. The demographic turning points in China and several European countries mean that labor scarcity and high labor costs are likely to persist. And even in the more demographically blessed United States, labor scarcity continues to be an issue and is likely to remain so unless and until immigration normalizes to pre-Covid levels. Finally, and this is particularly acute in Europe where ESG regulation is the most embedded, we have to factor in the medium-term high costs of an at-pace energy transition even if, in the long-run, it results in lower energy costs.
Added to this, we now have to factor in the impact of a surprisingly quick reopening of the Chinese economy, reversing three years of Zero Covid policy that stymied manufacturing output, damaged global supply chains, and depressed domestic consumer sentiment. If the U.S. and European reopenings have taught us anything, it’s that when economies reopen, consumers go “revenge spending.” An added twist to the Chinese reopening is likely to be a boost to global commodity demand as the manufacturing sector ramps back up, triggering an upswing in energy prices in the second half of this year.
The faster-than-expected China reopening has driven us to raise our global energy price forecasts. Chart 5 shows that we now have a curious “M” shape to our oil price forecast, for example, with prices falling faster than we had expected over winter 2022/23, but then building up again in late 2023/24 as Chinese demand comes back online, before settling back at a modestly higher level than previously forecast.
So, the upshot is that even after the peak of this credit cycle, we expect nominal interest rates and inflation to trend higher than before the pandemic.
Given that developed markets are no longer as energy intensive as during the 1970s oil shocks, the knock-on impact on consumer price inflation is more modest, but still noticeable in our revised numbers. Chart 6 shows that we are expecting c10-30 bps higher inflation depending on the market on average over the forecast period.So, the upshot is that even after the peak of this credit cycle, we expect nominal interest rates and inflation to trend higher than before the pandemic. But as Chart 6 shows, the big differential is in Japan, where the global inflationary surge looks like it has finally lifted both current and expected inflation. As a result, after years of aggressive Yield Curve Control policy, the Bank of Japan has opened the door to widening their bond yield band, and markets are now pricing in modestly higher bond yields and inflation. In the case of an economy which has been mired in deflation for decades, this is arguably a good thing and a sign of recovery.
Forecasting a change of monetary policy is particularly hard in Japan given that we are expecting a new Bank of Japan governor in April. We could have the 50-basis-point band reasserted, the band widened to 75 or 100 basis points, or YCC policy abandoned entirely. Accordingly, Chart 7 shows that we have chosen to take a median path through the potential forecast spectrum and are expecting Japanese bond yields to rise to 75 basis points in 2023, and then level out at 100 basis points thereafter, broadly in line with market implied forecasts. We acknowledge that this forecast is particularly fraught with uncertainty but take some comfort that even with bond yields at 1% for the first time since 2011, this would still leave Japan as the lowest inflation, lowest interest rate major market that we invest in.
A key point for real assets investors lies in our expectations for REAL interest rates because the income that we generate is often viewed as part way between nominal and real given our capacity to reset rents to market levels or to have contracts that are explicitly inflation-linked. As Chart 8 shows, we certainly expect real interest rates to run modestly positive once we get through the current correction. But this should be seen as a return to normal after a period of incredibly negative real rates. This is not atypical of the real bond yield environment that we saw in the immediate post-GFC period or in the mid-2000s – environments in which real assets were still seen as attractive.
Risks of a global recession recede
So much for the nominal economy, but what does all this mean for real growth? Well, as we said before, the warmer European winter has resulted in an earlier-than-expected recovery in a variety of high-frequency data. Chart 9 shows that whether we look at consumer confidence or several business confidence indicators, the trough of the correction seems to be behind us. As a result, we have revised up our European forecasts, with only a modest winter recession now penciled in, followed by a recovery beginning in summer 2023. That said, over the five-year forecast period the changes are a wash, given a worse demographic impact kicking into major markets such as Germany and Italy. However, we are forecasting Eurozone growth to average 1.4% y/y between 2023 and 2027, compared to 1.5% in the UK.Meanwhile, the faster-than-expected China reopening means that our forecasts for growth in the second half of this year have been revised up, with an impact in the latter years of the forecast period too. That said, on our forecasts, the fastest years of industrialization are over for China, and demographic factors are also weighing on medium-term growth, pinning it back to 5% y/y.
But the biggest change is arguably to our U.S. forecasts, where the ongoing strength of the labor market and strong consumer sentiment—despite housing market weakness—means that we have pushed back and softened our forecasts for a U.S. recession to a purely technical one starting in Q4. Thereafter, we forecast a strong recovery based on the assumption of ongoing labor market tightness and consumer strength. Accordingly, we are no longer forecasting a synchronized global recession. Indeed, it is highly likely that any U.S. recession will begin once Europe has started its recovery. Moreover, if anything, the China reopening bounce could, at the margin, help the U.S. avoid recession altogether, given its sheer economic size and importance to global trade.
Overall, the macro forecasts are now less pessimistic, with a softer European recession, delayed and softer U.S. recession and stronger China rebound. This is not to underplay the sizeable structural challenges facing the global economy: whether they be the overhang of government debt; demographic headwinds facing most markets ex-North America; or the cost of transitioning to lower carbon usage. However, the mix of modestly positive economic growth coupled with positive, but still fairly low, real interest rates, is a solid backdrop for real assets investors, once we have traversed the current correction.