Economics and Strategy

Focus Shifting from Inflation to Growth; Peak Tightening and Dollar Likely Favors Emerging Markets

Jefferies’ Chief Economist Aneta Markowska anticipates a recession in the U.S. beginning around Q3 as businesses respond to slowing revenues, higher wages and higher interest rates with cost cuts and layoffs. While inflation was the headline concern for businesses, consumers and policymakers in 2022, she thinks growth is likely to emerge as the bigger challenge in 2023. Whether the U.S. Fed funds rate peaks at 4.85% or 5.1% (her base case), Aneta expects the policy drag to be enormous either way. Small businesses, which accounted for all net new hiring during the past three years, are especially exposed given their high labor intensity and high floating rate exposure. In her view, the Fed is unlikely to cut rates unless inflation falls below 3% or unemployment rises to about 5%, both of which are more probable in 2024.

Chief Market Strategist David Zervos believes global macroeconomics remain at the highest level of relevance since the Global Financial Crisis for investment strategies and expects this condition to intensify in 2023. Looking back on last year, he noted credit market dynamics in particular were brutal as rising rates and widening spreads drove markets to levels not seen in some time. David believes that, while equities remain depressed, the pain is not nearly as acute as in credit. Looking ahead, return profile is likely somewhat capped by the Fed’s desire to ultimately bring inflation back down to 2%. Accordingly, he thinks stocks could be range bound for some time and prefers the risk/reward in the credit part of the capital structure, citing higher coupons and relative safety in the event of catastrophic economic outcomes.

Global Head of Equity Strategy Christopher Wood’s base case remains that monetary tightening expectations peaked with Federal Reserve Chair Jerome Powell’s press conference on November 2, 2022. In his view, if monetary tightening expectations have peaked, the strength of the U.S. dollar likley has as well. In addition, Chris believes a recession is likely to cause the Fed to cut interest rates later this year, a faster timeline than Aneta’s forecast that is driven by his related expectation for significant earnings downgrades. He notes that S&P 500 profits have diverged significantly on the upside above the macro measure of U.S. corporate profits in the national accounts. This is a concern since history shows that the usually more volatile S&P 500 series always converges with a lag in the macro measure of corporate profits, particularly in economic downturns. Looking toward China, Chris believes the country will avert an economic hard landing with the long anticipated central government stimulus package to address the downturn in residential property. This, in conjunction with relaxation of the Chinese government’s Zero-Covid policy, is likely to help unlock significant pent-up demand in the region.