In our 2023 Global Economics Outlook, published on December 28, 2022, we made accurate forecasts for the trajectory of the global economy in 2023. This new installment of Poseidon Weekly Foresight presents a comprehensive analysis of H1 events, providing further insights into the economic trends in various regions for the remainder of the year.

Summary

• The U.S. economy faces an intriguing dynamic where the permeation of high interest rates is expected to moderate inflation while sustaining job market resilience. We anticipate an additional Federal Reserve rate hike within the year, a soft economic landing, and the S&P 500 pulling back to roughly 4,000 points by year-end.
• China's economy reveals a recovery slower and less balanced across sectors than anticipated. The equity market awaits further stimulus from the central bank, while the property market lags. Geopolitical tension is likely to ease slightly but persist. We predict China's GDP growth rate to float between 5.3% and 5.5%.
• Foreign investors' infatuation with Japanese stocks, combined with a surge in post-pandemic tourism, could ignite external inflationary pressure. Our analysis suggests a Bank of Japan Yield Curve Control tweak in Q3 and the potential for USDJPY to climb to 125-130 within the year.
• Europe's economy is on track for a moderate recovery, albeit hampered by the ongoing Russia-Ukraine conflict. Despite May's eased inflation, the European Central Bank looks set to maintain its tight monetary policy.

United States - Sustained Rate Hikes and Credit Tightening, Stock Market Steers the Economy  

In the U.S., the enduring cycle of rate hikes and credit tightening combined with a stock market playing a pivotal role in steering the economy pose unique challenges. Inflation remained stubbornly high in Q1, coupled with a strong job market, ongoing stock market decline from January's peak, skyrocketing Treasury bond yields, and a strengthening dollar. However, the mid-March collapse of several small-to-medium-sized banks, led by Silicon Valley Bank, forced the Federal Reserve to reconsider its rate-hiking path, leading the government to infuse the market with liquidity to manage the banking crisis.

From Q2, a pivot in the U.S. equity market took place, fueled by a booming AI sector, which led to a rally in large tech stocks. A mere ten companies contributed over 90% of the S&P 500's rise. Although job market resilience persisted in May, gradual easing in inflationary measures tempered market fears of an economic downturn, pushing U.S. equities into a technical bull market.

The Federal Reserve's June assembly held back from another rate hike. The dot plot, however, showed that 16 of the 18 officials expect an end-of-year rate exceeding 5.25% (only seven forecasted this in the March dot plot). The revised median rate in the quarterly dot plot stands at 5.6%, suggesting the potential for two 25bps rate hikes in 2023. The market has ruled out the possibility of a rate cut in 2023, with a more than 70% expectation of a 25bps rate hike in July.

Our outlook suggests that high interest rates' ongoing impact on the real economy will result in a continued deceleration in inflation over the coming months, yet the job market should remain robust. Based on Powell's hawkish comments at the June policy meeting and congressional hearings, it's clear the Fed is resolute about raising rates if needed to keep inflation in check, keen to avoid a replay of the 1970s scenario. Despite this, we anticipate a single additional rate hike from the Fed this year, deviating from the dual hikes indicated by the dot plot. By year-end, we expect the U.S. policy rate to land between 5.25% and 5.5%, followed by a loosening cycle starting in Q1 2024.

Increased rates will likely exacerbate credit market contraction, pushing more regional banks into turmoil and amplifying SMEs' difficulty in securing bank support. Despite a surprising jump in the Consumer Confidence Index on June 27 to 109.7, well above the market consensus of 104, the rising cost of borrowing and tightening credit are expected to weigh on consumers and businesses, possibly eroding overall economic optimism and denting consumer confidence into summer and Q3.  

On the stock market front, large tech firms are poised to continue benefitting from the AI revolution, but the broader market will likely oscillate under the pressure of rising rates. The first half of the year saw the average stock prices of seven tech giants—Apple, Microsoft, Amazon, Google, Tesla, Nvidia, and Meta—rise by 54%, while the remaining 493 firms' stock prices remained static. We predict a 10% pullback in the S&P 500 index to around 4,000 points by year-end, though a hard landing appears unlikely.

Heading into an election year, the US-China relationship is likely to perform a delicate "tango" rather than "tandem". Prior to the election, we might witness a pattern of one step forward, two steps back. To garner more votes, Biden will need to prove to swing voters that the Democratic government is actively defending America's leadership on the global stage, while also occasionally extending an olive branch to China to ease the geopolitical tension.

‍China – A Recovery Slower Than Anticipated, Further Stimulus Required

During the first half of the year, the Hong Kong stock market experienced persistent volatility, with the Hang Seng Index showing relative weakness since the end of January. As of now, it still lags 15.43% behind its peak on January 27. While most tech companies boasted impressive earnings reports, this has not been mirrored in their stock prices. We attribute this primarily to a less-than-expected recovery in China's economy and heightened concerns from overseas investors regarding Sino-US geopolitical friction.  

China’s economic data progressively slowed after a promising Q1 start, with retail sales slightly falling short of expectations, investment declines, and the PMI staying below the boom-bust line of 50 for two consecutive months. Throughout the pandemic, Chinese households spent more than they earned, leading to a 7% rise in household debt levels and weakening borrowing capacity. Post-pandemic, people's savings exceeded their consumption, deposit balances rose, retail growth was disappointing, and the stock market lacked momentum. The record high in the broad money supply (M2), defined as cash circulating outside the banking system plus corporate deposits, savings deposits, and other deposits, did not translate into credit expansion.

This below-par recovery has added pressure to the central government. Although the PBOC unexpectedly lowered the seven-day reverse repo rate by 10 basis points in mid-June, we believe this has a limited impact on the overall environment. Firstly, consumption plays a limited role in China's macro economy compared to developed countries. Secondly, consumers are yet to fully recover from the pandemic shock, and are currently still in the "saving for the future" mindset. The reduction in deposit interest rates won't spur families to move funds out of the banking system and start consuming, given the uncertainties ahead. Thirdly, with the substantial rise in household debt during the pandemic, further borrowing capacity is limited, and revenge spending is unlikely to last.

In the real estate market, a majority of buyers opted for second-hand properties out of concerns about unfinished properties and limited new housing supply. This has slowed the recovery of the first-hand market, and banks remain cautious about real estate lending. The real estate industry faces increasing pressure due to waning confidence. Even though the government has left some room for regulatory policies, participants who have accrued debt due to past expansion, such as the recent defaulter, Henan's leading real estate company Central China, will continue to be affected.

Tech giants face sanction pressures from the US and its allies, which are unlikely to dissipate in the future, particularly for companies needing more advanced technology or equipment not yet fully produced domestically in China. The scope of future sanctions will further extend into areas like artificial intelligence, advanced medicine, and biosciences.  

Overall, China's economic recovery has been uneven across sectors and may remain so in the second half of the year. With the Fed continuing to raise interest rates, global demand receding, China's manufacturing momentum decreasing, and the recent weakness of the Renminbi, the stock market's ultimate rise still depends on further stimulus from the central bank. We forecast China's GDP growth rate to hover between 5.3% and 5.5% this year. Government efforts to achieve this target and bridge the gap between consumption expenditure and exports will play a vital role. China's government retains sufficient policy measures to reserve some room for adjustment.

Japan – Bullish Stock Market and Post-Pandemic Reopening Will Propel A Central Bank Policy Shift

The Nikkei Index this month pierced the 33,000 points barrier, marking a 33-year high and instilling newfound confidence in domestic investors, while attracting a plethora of international investors. Besides the influential push from Warren Buffett Effect and the weakening yen, Japan's geopolitical stability has turned it into a favorite destination for hot money, serving as a safe harbor.

Furthermore, the weakening yen will continue to favor the export and tourism industries. With the arrival of summer and Japan's reopening post-pandemic, we anticipate a substantial influx of tourists to Japan, thereby triggering external inflationary pressures. In its April meeting, the Bank of Japan indicated it would patiently maintain its loose monetary policy while adapting flexibly to changes in economic activity, inflation, and financial conditions. Over the past year and a half, Japan's inflation has consistently exceeded the target inflation rate, paving the way for the termination of loose monetary policy. The robust stock market will also be an additional push in this direction.

In the past three "lost decades", Japanese society overall has demonstrated sufficient resilience and depth to tolerate a weaker yen for some time. Therefore, the Bank of Japan is not currently in a hurry to take immediate action. We still believe that as the consumer price index gradually seeps into household life, pressures will steadily mount, forcing the Bank of Japan to adjust its yield curve control policy correspondingly in Q3 of this year to avoid uncontrollable inflation. The recent one-year extension of the term of senior officials in the Foreign Exchange Office is one of the signs of Japan's upcoming policy adjustments. We maintain our previous view that the yen has a chance to appreciate to 125-130 by the end of the year.

Europe – Persistent War Impact, Monetary Tightening Continues

EU countries have been impacted by the Russia-Ukraine war. While an unanticipated mild winter helped avert an energy crisis at the end of last year, the situation hasn't completely dissipated. Rising food prices continue to pressurize household consumption. Germany, as the front line against Russia, sees internal discord on resource allocation. French President Macron finds himself in a China-US-Europe predicament after his China visit, pushing his approval rating to an all-time low. The UK, under new Prime Minister Sunak, is still deeply affected by high inflation.

Looking forward, we expect a modest recovery in Europe's economy, but overall stagnation will persist as tight monetary policy supersedes inflation as the brake on a more robust recovery. Moreover, waning fiscal support will be another factor limiting economic growth below the trend.

Regarding inflation, both the core prices and the overall inflation rate in May saw an unexpected drop. We predict that inflation will continue to fall in the coming months, but the European Central Bank will continue to tighten monetary policy. We expect this round of rate hikes in Europe to end in July.

‍

‍