Eight key global macro themes for 2023

Cedric Chehab, Global Head of Country Risk at Fitch Solutions Country Risk & Industry Research, outlines key themes that will shape the coming year.

At the end of 2022, we identified eight major economic and political themes that will shape 2023. As we have seen over the past two years, the outlook can change rapidly given unforeseen and volatile events. We are moving from a period in which one or two major risks dominate (such as the COVID-19 pandemic or Russia’s invasion of Ukraine) to a period in which there will be a multiplicity of smaller-scale risks. This creates more idiosyncratic problems for the global economy as well as individual economies.

These, for example, could include the greater presence of smaller-scale domestic and geopolitical security risks as well as hidden pockets of leverage within the financial sector (such as with crypto exchanges or asset managers) which could become exposed by elevated interest rates and weakening economic fundamentals. Here, we outline some of the major themes. We have not included the Russia-Ukraine war as a theme in itself because we anticipate that the conflict will continue throughout 2023, with neither side achieving a decisive victory.

Theme 1: Sharp slowdown in global growth, but nuances exist

We expect that global real GDP growth will slow from 3.1% in 2022 to 2.0% in 2023. Other than the pandemic in 2020, this would mark the slowest pace of growth since the GFC. Developed markets (DMs) will be hit hard, with a painful recession in the eurozone as well as a light and short recession in the US. Europe will be the region that suffers the most, contracting by 0.6% in 2023 (the eurozone will contract 0.5%) given rising interest rates, the ongoing energy shock, and a sharp decline in business and consumer confidence.

A contraction in output in developed Europe, combined with elevated inflation elsewhere, will also weigh on emerging Europe, where we expect that output will contract by 1.1% in 2023. We forecast that the US economy will slow to 0.3% over 2023 as a whole and will see two consecutive contractions in output in the latter part of 2023 as well as a rise in the unemployment rate. 

Theme 2: Inflation will ease slowly, leading to still-tight monetary policy

While leading indicators such as commodity prices, shipping rates and inflation expectations all point to weaker price growth, it will take a while for headline inflation to reach central bank targets. While inflation will trend lower over 2023, it is unlikely to hit central bank targets over the next nine-to-12 months in most economies. Inflation will remain sticky in those economies that have been hit by large supply shocks, such as European economies and, in particular, in emerging European economies that depend on a high level of imported energy, food and staples. The pickup in growth in China could see commodity prices surprise on the upside in 2023, which could further slow the decline in inflation rates.

Theme 3: Fiscal policy will tighten

We expect that fiscal policy in most major economies will tighten in 2023 due to three main reasons: 1) Governments rolling back emergency spending plans launched in 2022 (Germany, China) 2) Higher bond yields and greater pressure by market forces (UK, Italy), and 3) A greater focus on fiscal consolidation by legislators (US).

In aggregate terms, government spending will fall by 1.0% of global GDP. Among major economies, we expect the most tightening in China (where 2023 spending was frontloaded into 2022), Germany (where spending temporarily surged in 2022 due to economic support measures), Russia (where the economy will continue to contract) and the US (where the fiscally hawkish Republicans now control the lower house).

Theme 4: US dollar is not a one way bet anymore

A combination of factors saw the US Dollar Index appreciate by 11.0% over 2022. While we believe that many of these factors will remain in play over the coming months, the US dollar will struggle to maintain its uptrend over 2023 and instead will likely peak, if it has not already. The major driver of the US dollar in 2022 was an increasingly hawkish Fed as well as rising geopolitical risk, particularly Russia’s invasion of Ukraine. However, there are several reasons why we believe that the US dollar will not be able to repeat its performance in 2023.

Theme 5: Fragmented parliaments will stymie policymaking

In 2023, increasing risks of protests and rising divisions between executives and legislatures will make policymaking more difficult. A combination of dissatisfaction with economic conditions and busy election cycles have already cost several governments their majorities in parliament in 2022, including in the US and France.

Elsewhere, other internal tensions have led to major legislation being delayed, such as Germany’s new, modestly more generous social welfare system. In terms of EMs, despite winning the presidential race in Brazil, President Luiz Inácio Lula da Silva's party does not have a majority in congress, and the November 19 2022 election in Malaysia resulted in a hung parliament. These difficulties are reflected in our proprietary Short-Term Political Risk Index (STPRI), which continues to trend downwards across all regions on a GDP-weighted basis. Among large markets, this has weighed on European and Latin American markets in particular, the majority of which have experienced large negative revisions to their STPRI scores.

Theme 6: Tensions between the US and mainland China increase

We anticipate that tensions between the US and China will increase in 2023 as the newly Republican-controlled House of Representatives raises pressure on the Biden administration to adopt tougher stances on Beijing, and the latter responds accordingly.

First, we believe that Congress will press for greater US support for Taiwan, China by means of the proposed Taiwan Policy Act of 2022 (which aims to provide greater security assistance for the market) and the US-Taiwan Initiative on 21st Century Trade (which aims to increase two-way trade and investment). Second, the Biden administration is likely to strengthen its alliances with Japan, South Korea, the Philippines and Australia to counterbalance Beijing’s influence in the Indo-Pacific region. This will complement initiatives such as the new Indo-Pacific Economic Framework for Prosperity, which includes 12 Asian markets. Third, the US is likely to introduce further restrictions on high-tech goods exports to China the competition between the two markets over semiconductors and next-generation technologies increases. Fourth, the Republican party is likely to raise the rhetoric against China, which, even if does not immediately affect policy, is likely to create a more negative.

Theme 7: Global property markets come under pressure

After a decade of rapidly rising residential property prices in most DMs, there are indications that the
global housing market is losing momentum. This is the result of monetary tightening, which is raising the
costs of servicing mortgages and, which will in turn squeeze the budgets of consumers who are already suffering from falling real wages. To the extent that a buoyant property market acts as a means of supporting the economy, a downturn will add to the macroeconomic headwinds. Housing market activity matters for the wider economy for a number of reasons.

First, housing market turnover supports associated activity such as outlays on household goods. Second, in many DMs, consumers are able to borrow against the rising value of their property, which supports consumption (so-called mortgage equity withdrawal).

A third issue is that falling house prices have a particularly adverse effect on consumers the more highly leveraged they are, particularly in an environment where households are subject to variable mortgage rates or where mortgages are fixed for relatively short periods. This is a particular problem for markets such as Australia and Canada. Finally, weak housing activity discourages residential investment, which has a direct impact on GDP growth. For all these reasons, a softening in housing market activity and prices will pose downside risks to DMs in 2023.

Theme 8: Unemployment rates increase, but less than In previous cycles

We anticipate that labour markets will weaken in 2023 as economic activity softens, reversing a tightening trend that started in late 2020. That said, unemployment rates will not rise as much as they have in past economic cycles, going some way towards mitigating the impact of a weaker global economy on households and businesses. For example, we forecast a 0.7 percentage points  rise in the US unemployment rate to 4.5% by the end of 2023, which would be a significantly lower increase than in past recessionary cycles. Looking at the last two (pre-pandemic) recessions, the US
unemployment rate rose by 1.8 percentage points to 5.7% between 2000 and 2001 and by 2.6 percentage points to 9.9% between 2008 and 2009.

Below-normal labour force participation rates in the US and the UK have been a key contributing factor to tight labour markets and a lowering of unemployment rates over the past two years (see chart). US labour force participation rate dropped from 63.4% in early 2020 to a low of 60.2% in April 2020 before rising gradually to reach 62.2% as of October 2022. Likewise, in the UK the participation rate dropped from 64.4% in February 2020 to 62.9% as of September 2022. Still-generous spending by governments could also help to prevent a larger weakening of the labour market, particularly if direct transfers similar to those seen during the pandemic are provided to businesses.

This commentary is published by Fitch Solutions Country Risk & Industry Research and is not a comment on Fitch Ratings' Credit Ratings. Any comments or data are solely derived from Fitch Solutions Country Risk & Industry Research and independent sources. Fitch Ratings analysts do not share data or information with Fitch Solutions Country Risk & Industry Research.