The pandemic and the recent relaxation of restrictions continue to reverberate through the global economy and cloud the outlook. For insight into what may lie ahead, Jarden investment strategist and economist John Carran shared his thoughts, at the time of writing on 18 November 2022.
Through the haze, we see potential improvements in inflation but also see the global economy flirting with recession. In this environment, financial markets may waver in the near-term. Longer-term, prospects for share markets and bonds still look promising. The most glaring consequence of the pandemic, and the responses to it of governments and central banks, has been rapidly rising prices.
Clogged supply chains and the war in Ukraine, combined with rampant consumer spending, have caused prices for energy, food, and goods to rocket up globally. Record low interest rates boosted house prices and led to higher housing-related costs. Despite the immediate headwinds for New Zealand’s economy, household finances are in reasonable shape, with many having built their savings over the pandemic.
This could provide some buffer to tougher conditions ahead. With global supply chain pressures now easing and commodity prices falling, inflationary pressures may soon ease. Cooling housing markets in New Zealand and elsewhere are also expected to gradually moderate inflation. However, prices in consumer services tend to be stickier. Therefore, although total inflation is expected to continue edging down, there will likely be a significant remnant that will linger for longer.
How long high inflation lasts is also likely to be influenced by pressures in the labour market and how fast wages grow. This will impact the pace of consumer spending and the degree to which businesses pass higher wage costs on to their customers. This is a key risk for central banks in their quest to get on top of high inflation. While heated labour markets may cool somewhat in the first half of 2023 as labour market churn settles down, it may take a spell of higher unemployment to settle wage growth to a more sustainable rate. Although there are reasons to expect inflation pressures to ease a little in the near-term, the US Federal Reserve (the Fed) and other central banks are unlikely to slow the pace of interest rate increases this year.
Central banks presently consider the risks of not doing enough to control inflation are worse than the risks of doing too much. However, by mid-2023, we expect many developed economies to show signs of slowing, including labour market cooling, and core inflation shifting down. This will likely be enough for the Fed and other central banks to halt their interest rate rises. Interest rate rises tend to influence economies with a considerable lag, so recent rapid rate increases should take their full effect through 2023. The more central banks raise interest rates in the near-term, the more likely it is that economies will enter recession next year and possibly through to 2024.
Therefore, it’s also possible that the general economic uncertainty, which has caused share and bond market volatility this year, may persist for a while longer. On the other hand, share valuations have materially declined this year, which means the potential return from shares in the longer term could be favourable. With interest rates now higher than they have been for at least a decade, bonds could similarly offer improved investment yields.
In New Zealand, we are facing similar inflationary and economic pressures to many other countries. The coming year could be challenging as recent interest rate rises start to bite. Many people that locked in low interest rates on one- and two-year fixed mortgages will soon be rolling onto much higher rates.
With the local housing market already feeling the effects of higher interest rates on mortgages and house prices falling almost 13 per cent from their peak at the end of last year, New Zealanders’ confidence and ability to spend could be adversely affected. Despite the immediate headwinds for New Zealand’s economy, household finances are in reasonable shape, with many having built their savings over the pandemic. This could provide some buffer to tougher conditions ahead. In this less certain environment, we often work with clients to diversify their investments in a way that meets their goals and timeframes. This can help with navigating the route ahead in a way that suits your individual circumstances.