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January 18, 2023

Many people are going to be very wrong in 2023

Many are convinced that the Fed will pivot. Many are not. One camp will be proven wrong.
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Guest blogger
Keith Campbell
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“I think there is a world market for maybe five computers.” Thomas Watson, president of IBM, 1943.

“We’ll be fine.” Jim Balsillie, BlackBerry co-CEO, after Apple’s iPhone launch in 2007.

“We do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system.” Federal Reserve Chairman Ben Bernanke, 2007.

Putin is bluffing over the Ukraine.” Edward Luttwak, geopolitical strategist, Jan. 16, 2022.

History will look back at the start of 2023 as a moment when two tribes in financial markets had very different interpretations of the world. One of them might seem deluded in retrospect. There will be some embarrassing quotes for future end-of-year outlook writers to mock. But at the current moment, both teams are well within the mainstream and have plausible cases.

I’m speaking, of course, of the most big-picture issue in macroeconomics: the outlook for interest-rate increases by the Federal Reserve and other central banks. Pick your cliché: rock, hard place. Scylla vs Charybdis. Irreconcilable differences. A lot of money is at stake for those who get it wrong. (1994 bond crisis, anyone?)

As I compiled 2023 outlooks from the financial professionals that make up the Macrobond community, there was broad consensus that the US would at least flirt with recession in 2023, if not drag the world into a global slowdown. But their big-picture views of inflation and the pace of rate hikes by the Fed tended to fall into one of two camps.

For the first camp, another cliché: “don’t fight the Fed.” It believes Fed Chairman Jay Powell will hike rates to whatever it takes to tame inflation and “channel his inner Volcker,” as my colleague Karl Philip Nilsson put it in a September blog, referring to the most famous inflation-crusher in central banking history. As one of our pundits writes, inflation will be sticky, so expect the Fed to “pause – not pivot” in 2023. Another cites “misplaced macro narratives” that led investors to be wrongfooted and believe inflation would remain conquered. Another says “The Fed’s battle isn’t over.”

We recently re-examined one of our Charts of the Week, tracking how persistent inflation has led futures markets to anticipate a peak Fed rate of 5% in 2023 (unthinkable a year ago), with the Bank of England not far behind. 

The other camp has some overlap with “team transitory” (whose view that inflation was a post-pandemic blip had a rough ride in late 2022). They believe inflation is coming down rapidly. One of our pundits fully expects the Fed and ECB to pivot to a dovish stance to support growth. Another warns of a “real risk of overtightening; expect rates to fall off a cliff.”

My own instincts tend to put me in this latter camp. I remember the “taper tantrums” of 2013 and 2018, when the Fed was criticised for making a “policy error” and eased off a hawkish stance.

(You can find variants of this view in both mainstream and “alternative” media. This is broadly the view of the Eurodollar University podcast by Jeff Snider, formerly of the hedge fund Alhambra Investments. Snider sees the behaviour of the vast pool of Eurodollars – dollar deposits held outside the US – as a more important determinant of what will happen to the price of money, and inflation, than anything the Fed does, and he believes inflation is well on its way down.) 

If Powell’s hawkishness is doing too much damage to markets, the real economy, and America’s allies (via currencies tumbling against “King Dollar”), I think the Fed chairman might blink. 

But I could be wrong. I have never seen a moment where two narratives have clashed so strongly. 

Here’s what else was notable to both myself and the Macrobond community:

China’s reopening. Observers of Thailand and its currency mentioned this issue, given the importance of the nation’s tourism industry. The initial euphoria of the “China reopening trade” has given way to a more measured attitude, as surging Covid cases lead to a different form of disruption than the previous regime of rolling lockdowns. Western companies are unlikely to abandon “reshoring” strategies after the past years of issues with Chinese supply chains, but Asia’s biggest economy could roar back to life, surprise the bears concerned about the drag from the deflating Chinese housing bubble, and drag global GDP from the doldrums.

Zoltan Poszar: This Credit Suisse analyst is producing some of the most interesting research about the biggest of big pictures: the US dollar’s future as a reserve currency. His last note of 2022 envisioned a world where China works with Russia and the Gulf Cooperation Council oil-producing nations to secure commodities and pay for them in yuan. He doesn’t predict that the Chinese currency or state-backed crypto will eclipse the dollar, but points out that it may lead to commodities “trapped” outside the dollar system, leading to longer-term scarcity – and inflation – that the West is unprepared for.

Ukraine: Finally, the wild card none of our outlookers chose to touch is the prospect of an end to Russia’s war. Whether through regime change in Moscow or Kyiv pivoting to acceptance of a negotiated settlement, I would be tempted to buy one of “Black Swan” author Nassim Nicholas Taleb’s “lottery tickets” betting on a positive commodity price shock: fewer disrupted agricultural commodity shipments, more Russian crude on western markets.  

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