The MTC Investment Team presents the 2023 Market outlook:
- The Great Reset – Jason Ritzenthaler, CFA, CTFA
- Fixed Income Update – Kate Braddock, CFA
- Equity Market Outlook – Jonnathan De Jesus CFA, CIPM
- Economic Outlook – Chris Morgan, CFA, CFP®, CAP
- Earnings Update – Katie Cihal, CFA, CPA
- Geo-Political Update – Sharon Giuffre, CFA, CAP
Fixed-Income Update – Kate Braddock, CFA
We started 2022 being told that “there is no alternative” (TINA) to the stock market. With bond yields near zero, what choice was there? This being the case, we kept our fixed income exposure short duration and high quality in order to minimize portfolio exposure to the rising rates we expected to see in the market. As we enter 2023, we believe that TINA has left the building and BARB (or “Bonds Are Back”) has taken her place. After an extremely difficult year for bonds, we are optimistic as we venture into 2023. Inflation has moderated, bonds are now yielding high enough interest rates to make them attractive, and we believe that the majority of the US Federal Reserve’s rate hikes are behind us. Given these conditions, we have begun to lengthen duration in most of our clients’ portfolios, where appropriate.
At this time last year, the Federal Reserve was forecasting that real GDP would grow 4.0% in 2022, that inflation would be running at about 2.5%, and we should expect three, 0.25% rate hikes by the end of the year. Instead, it looks like real GDP will be up about 0.5%, inflation is up 5.5% year-over-year, and we have seen 4.25% in Fed rate hikes, finishing the year at 4.375%1. No longer are central banks around the globe complacent about inflation as they were at the start of the year. They have acted in unison to aggressively combat the rapid inflation that turned out not be “transitory”. Central banks in the developed world have simultaneously hiked interest rates by roughly 2-4% each – the fastest pace in the past 40 years. No part of the bond yield curve was spared from rising interest rates. On the short end of the curve, rates increased more than 4%, and in the middle of the curve, the yield on the five-year Treasury rose approximately 2.5%. On the longer end, the 10-year Treasury yield rose more than 2% to 4.2% before ending 2022 at 3.9%2.
For 2023, the Fed is forecasting another year of 0.5% real GDP growth, inflation of 3.1%, and the unemployment rate rising to 4.6%. Their dot plot shows another 75 bps of rate hikes in 2023, and no planned cuts3. Despite the central bank’s consistent messaging that it plans to lift rates higher from the current 4.25% to 4.5% target, the futures market is pricing in rate cuts late in the year1. Expect the actual path to be data driven in the months ahead.
The question on everyone’s mind is whether the Fed will tighten monetary policy so much that it sets off a recession. The Fed has hiked rates at the fastest pace since the 1980s. In 2022 there was 4.25% of hikes. The yield curve, as measured by the spread between two-year and ten-year Treasury yields, is inverted indicating expectations of both lower inflation and recession. Looking forward, from an economic point of view, we expect that the U.S. economy will slow in the first half of the year but remain positive. If a recession were to occur, we believe that it would be short and mild, and that economic growth would reaccelerate in the second half of the year. In either case, high quality fixed income will likely rally as investors seek safety. Based on this, we have lessened corporate bond exposures and increased exposures to Treasury bonds.
After a difficult year for bonds, there are reasons for optimism. Yields are the highest we have seen in years, inflation has moderated, and the end is in sight for the current rate hike cycle. The combination of higher yields and relative safety make fixed income attractive to investors in times of volatility. We believe growth will be lower but still positive in 2023, that the Fed will continue to raise rates to 4.65%, peaking mid-year with the potential for minimal rate cuts in late 2023. After many years of rates near zero, bonds are back.
External sources: CME Group1, Google Finance2, St. Louis Fed3
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