State Street Global Advisors tips disinflation to become apparent in the first half of 2023

The world’s third biggest asset manager has lowered its global economic growth forecast but says once disinflation becomes apparent by mid 2023, central banks will ease up on rates.

State Street head of investments Jonathan Shead. Picture: John Feder

State Street Global Advisors sees a risk of persistent inflation leading to further interest rate hikes, recessions and global financial markets instability in 2023 but maintains that inflation will fall significantly within six months, allowing a downward reset of interest rate expectations.

In its 2023 outlook, the world’s third biggest asset manager lowers its global economic growth forecast to 2.6 per cent from 3.1 per cent three months ago as a global economic slowdown intensifies across both developed and developing economies.

It’s concerned about the risk of “overtightening” by central banks, given the speed and aggressiveness of their interest rate increases, in a world where growth looks set to remain volatile amid the protracted war in Ukraine and its troublesome implications for European energy supplies, and the lingering effects of the Covid-19 pandemic on supply chains, migration and consumers.

But while inflation remains unacceptably high at the moment, the global fund manager says a range of leading inflation indicators — led by a more than 60 per cent fall in the price of Brent crude oil from a two-decade high of $US134.91 a barrel in March, to a an 11-month low of $US75.77 in December – suggests that a “powerful disinflationary episode lies ahead” as growth slowdown hits.

“We’re watching this risk of overtightening very closely,” SSGA head of investment Jonathan Shead said.

“We think the speed of rate hikes has been necessary, but we’re past peak inflation.”

He says inflation indicators are already starting to fall, there’s no sign that expectations have become unanchored, and that supply chains have improved and demand is easing.

He expects disinflation to become evident in the first half of next year, leading central banks to end their rate rises, which will in turn give a good buying opportunity in risk assets like shares.

Moreover, despite the fastest interest rate increases by Western central banks in decades, evidence of inflation expectations taking off is “scant”.

And despite a lot of talk about a new higher inflation regime being pervasive, the timing and magnitude is “highly uncertain and improbable”.

Meanwhile, SSGA says the risks to economic growth remain to the downside relative to its forecast and the substantial appreciation of the US dollar this year has intensified global growth challenges.

After rising as much as 28 per cent in the past two years, global economic growth faltered and US interest rates began to soar, the US dollar index has fallen about 9 per cent from a two-decade high in September but its rise this year could still expose unanticipated vulnerabilities.

The global macroeconomic and geopolitical environment remains “especially challenging” for the emerging markets (EM), particularly in economies that are more vulnerable to pricing shocks from energy, food, and raw materials.

Coupled with ongoing monetary policy tightening in most of the major economies and the continuing slowdown in global demand, and tensions between the US and China, the fund manager sees a tough backdrop for EM economic growth.

“Our core view is that, despite these vulnerabilities, at some point over the next six to 12 months conditions will likely begin to improve,” SSGA says.

A key signal would be clear evidence that the inflation surge of the past year is beginning to subside.

SSGA is optimistic that inflation will be trending materially lower within six months, allowing a reset of expectations about how long policy interest rates need to remain deeply in restrictive territory.

As markets adjust to this future dovish shift, it expects the US dollar to take a breather, supporting financial stability in EM economies.

But goods demand is unlikely to rebound in any meaningful fashion over the course of next year.

Especially in the US, goods demand needs to normalise lower from a “Covid-induced overshoot”.

The only notable exception to this downshift it sees is automotive demand, where supply limitations have precluded the rebound in sales seen elsewhere in goods.

But commodity demand is expected to remain robust, specifically for energy and foodstuffs.

SSGA also expects some replenishment of inventories to support commodity prices and export revenues for a wide swath of emerging markets.

Despite an “underwhelming demand outlook”, it sees a moderate improvement in emerging markets growth, driven primarily by an acceleration in China from a weak 2022 performance, with a modest recovery in housing investment, and easing domestic Covid-related mobility restrictions.

An improving geopolitical landscape is anticipated with key political events, including China’s Party Congress and the US midterm elections, out of the way and “compelling reasons” for the US and China to seek to scale back their rhetoric, although while SSGA sees “no clear off-ramp in the Russia-Ukraine War”, it notes that any de-escalation would help confidence.

For the share market, it says a sustained rise is unlikely before mid-year.

But it also says that at current levels, “most bad news has already been priced in”.

“Our base case thinking about the timing of a pivot to a sustained upside move in equities is the second half of 2023,” it says.

Originally published as State Street Global Advisors tips disinflation to become apparent in the first half of 2023