2023 Outlook: Recession or Recovery?

Ms Selena Ling, Chief Economist & Head, Global Markets Research & Strategy, OCBC Bank

Ms Selena Ling, Chief Economist & Head, Global Markets Research & Strategy, OCBC Bank

Heading into 2023, the near-term economic outlook seems bleak with rising recession risks and elevated inflation. Hopes for post-pandemic recovery are in the process of petering out. The major economies may face a synchronised downturn due to idiosyncratic risks, namely the aggressive frontloading of monetary policy tightening in the US, energy crisis in Eurozone, and the zero-Covid strategy and property market weakness in China. Elsewhere, the Emerging Market (EM) economies are grappling with USD strength, fickle portfolio flows, persistent geopolitical tensions between the major powers, and separate waves of supply-side and commodity-driven inflation shocks.

However, things might not be all doom and gloom. Instead, the 2023 outlook could fall into a story of two halves. The first half may still see bouts of heightened market volatility as investors continue to read the tea leaves and second-guess when central banks will pivot and pause or eventually cut interest rates. There are two key factors to watch in the second half. Firstly, whether the Fed’s terminal rate will peak closer to 5% or 6% handle and if the US growth slowdown and moderation in inflation would be significant enough for the Fed to claim victory and precipitate a policy reversal. Secondly, when China relaxes its zero-Covid strategy in a more meaningful fashion beyond the recently announced measures. These two factors could be a turning point and provide some upside risk.

"The major economies may face a synchronised downturn due to idiosyncratic risks, namely the aggressive frontloading of monetary policy tightening in the US, energy crisis in Eurozone, and the zero-Covid strategy and property market weakness in China"

For now, the US economy appears to be fairly resilient. Consumer spending is holding up well amid a tight labour market that has shown little signs of softening despite layoffs by big tech companies amid the global growth and demand slowdown. The recent crypto-currency fallout sparked by FTX.com also appears to have limited contagion to other asset markets. Yet, as oil market gyrations suggest, investors remain sensitised to demand-supply shifts and OPEC+ signals as the latter’s output cuts and hikes can play a swing role amid the anticipated impact of the upcoming EU’s embargo on Russian oil. The G7 proposal to cap Russian seaborne oil prices will factor here too, especially given the gap between the price cap and the market spot price.

room is China. While China’s 2022 growth prospects have been beaten down, the base effects and policy relaxation could mean a more conducive environment for 2023 to see an improvement. At this juncture, repeated upticks in Covid infections that warrant stricter measures are still the norm. While a soft-landing scenario for the Chinese economy is still our base case in 2023, it will likely be characterised by bouts of market doubts and policymakers vacillating between relaxation and tightening to find the right balance amid headwinds of a weak property market, geopolitical bifurcation and fickle consumers.

For ASEAN, it is premature to call the peak of monetary policy tightening yet if the Fed continues to nudge its expected terminal rate higher in the interim due to persistent inflationary pressures. If capital outflows materialise based on the divergence between developed and emerging markets, then ASEAN central banks may have to keep going with the monetary policy tightening and this could include the likes of Bank Indonesia and Bank Negara Malaysia.

In Singapore, the stalling of manufacturing momentum may mean that downside growth risks are likely to loom large in the coming months. However, this should not detract from the ability to provide fiscal support at the upcoming Budget 2023 and also not constrain MAS at the April monetary policy review. Since headline and core inflation will largely be underpinned by domestic cost drivers (including GST hike, Progressive Wage Model salary adjustments, public transport fare hikes, tight labour market), the window is still open for a monetary policy tightening barring a clear downtrend in inflationary pressures.

The key question is whether the worst is over for the inflation scare, and if it could precipitate a policy recalibration. If that is the case, then bargain hunting opportunities are likely to emerge. Since financial markets are always forward-looking, risk appetite and recovery are likely to emerge and sustain once the bottom is in sight. There is still some room for cautious optimism even taking the near-term economic outlook into consideration.

In the face of profound uncertainties, we can turn to three key structural drivers that could impact the health of the global economy. The first is financial market stability. Heightened volatility in a weak financial system can amplify shocks and remains a potential test of financial and economic resilience. With the growth of non-bank finance, the macro-prudential framework will need to be strengthened further to withstand the assault of cybersecurity threats amongst others. Nevertheless, the inter-connectedness of the global economy and financial systems has mostly been a boon for uplifting growth and incomes, but also exposed the risks of over-dependence and the efficiency-security trade-offs, and the need for fresh shock absorbers.

The second driver is ESG. Business models need to be more focused on environment, social and governance goals and targets, even as they continue to innovate and meet new customer needs and demands. For banks, the financial risks of climate change are already at the forefront as regulators have built the topic into the stress test scenarios, while investors and asset owners are also embedding sustainable investments into their investment frameworks. Finance can play a key role to drive and assist in the green transition.

Finally, bilateral and multilateral cooperation can also make an impact. Although the global policy coordination landscape is by no means perfect, the recent cluster of G20, COP27 and other high-level talks saw countries reinforcing their commitment to strengthen cooperation in the face of a more challenging global economy and financial outlook to build a more inclusive, sustainable and resilient recovery.