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Bipolar market sentiment: Negative for US & Europe, Positive for China: Market Commentary January 2023

Market Context

Global Macro: Europe and US market sentiment is quite negative due to the uncertainty of economic drivers. We expect market participants to stay in “wait and see” mode until they can get clarity regarding the following 3 points. First, recession: when will it start and how long will it last? Second, inflation: are we seeing the inflection point now and is inflation going to decline steadily in 2023? As a point of note, food and energy prices have already declined around 20% to 30% from 2022 highs. Thirdly, central banks’ “terminal rates”: up to what level will central banks keep on hiking short-term interest rates? Our estimate is that the Fed will go up to 5.5% and the European Central Bank (ECB) up to 3%.

Market participants, corporations, and investors need to be able to estimate answers for these questions in order for financial markets, real estate, private equity, and private debt to get out of the current bearish valuation trend. As inflation is showing signs of slowing down following the declining energy and food prices, we anticipate that Western central banks – in particular the Fed, ECB, and Bank of England (BoE) – will reach their terminal rate (i.e. the short-term peak rate) around mid-2023. Although central banks hiking rates may reduce inflation, it will also increase pressure on Western economies’ growth.

  • In the US: price-salary inflationary loop

The fast pace of salary increases in the US is feeding the higher price-higher salary loop underpinning inflation. The labor market remains tight in the US with 1.7 vacancies for every unemployed person. Consequently, the US central bank may not be able to stop hiking interest rates for the time being as inflation is supported by raising salaries and an excessive demand for workers. The minutes of the Fed’s latest policy meeting in December suggest that the Fed funds rate would increase by 50bps from 4.5% to 5% at the next meeting on February 2nd .

  • In Europe: war zone

Unfortunately, the war in Ukraine has no end in sight, which puts a constant stress on the European economy and the euro currency. Given this unstable backdrop with little visibility, foreign capital is not coming back to Europe. Inflation, due in great part to the energy and food supply disruption in Europe, is negatively impacting the economic activity. Europe is entering a recession period that is unlikely to end unless there is a ceasefire in Ukraine. This translates into a negative trade balance of -USD 30bn per month. The war, recession, and negative trade balance are capping the euro upside below 1.08. To combat inflation, the ECB continues its interest rate hiking program from 0 last summer to 2% at this time (ECB deposit rate) and has communicated its intention to hike by another 50bps on February 2nd up to 2.50%, the highest level since the Great Financial Crisis of 2008.

  • In China: full re-opening of the economy

The situation in China is the opposite of what we see in Western economies. As China is fully re-opening its economy, the market sentiment is quite positive for Chinese assets. It seems the market is ignoring the human cost of the quick Covid policy turnaround. This has materialized in a rally of 30% in Chinese stocks over the last two months of 2022 and a rally of 8% in the first trading week of 2023. The RMB is also strengthening with the Chinese currency rallying 8% in the past two months. In China, short-term interest rates remain close to 2% and the People’s Bank of China (PBoC) is likely to keep rates stable at this low level (for Chinese standards) in order to facilitate the recovery of the real estate sector. China’s inflation has been dropping steadily for the past 6 months and is now at 1.6%. With the economic re-opening amid a steady monetary policy environment and low inflation, China’s economic growth for 2023 is expected to reach 5%. The trade balance is already back to close to the all-time high with an average of +USD 80bn per month.

Financial Markets:

Equity: Global equity markets contracted in December amid recession fears (S&P 500 -2.9%; Euro Stoxx 50 -3.4%; Nikkei 225 -6.7%), except for Chinese equities, which ended the year on a positive note (HSCEI +5.2% in December), driven by China’s re-opening. Fixed Income: The 10-year US yield edged up 9bps to 3.83% in the last month of the year, while the 10-year German yield rose 46bps to 2.38%. Currencies: The greenback continued its weakening trend in December: EUR +2.9%, AUD +1.0%, CNY +2.1%, JPY +5.1%, CHF +2.7%. Commodities: Gold gained 2.7%, while oil prices further declined 2.2%.

What to expect for the start of 2023

  • Equities: volatility in the first semester

As Western central banks, led by the US Federal Reserve, hiked interest rates steadily and substantially, Western equity markets mechanically declined in 2022 (stock valuations have an inverse relationship with respect to interest rates as they reflect higher financing costs in the future). Stocks having the longest duration (i.e. growth stocks with high price-to-earnings ratios) are the most affected by the rise of interest rates. The worst case being the Nasdaq stocks, which are down 33% in 2022, caused by the USD interest rate movement, the highest and fastest among all currencies. We believe we will see lower inflation in 2023 and consequently expect that around mid-2023 Western economies’ interest rates will stop rising. Therefore, we anticipate more volatility in the first semester of 2023 for Western markets and potentially a rebound in the second semester. After that, hopefully, the global macro backdrop will be more market friendly: exit of the Covid pandemic, ceasefire discussion in Ukraine, declining inflation, and normalized monetary policy.

  • Currencies: dollar reversal

USD: Down reversal. In September 2022, the US dollar reached its highest level in decades following a rally on the back of fast and substantial interest rate hikes (US Fed funds rate went up 4.5% in 2022) and a USD flight to safety due to rising global geopolitical concerns. The overvalued USD has resumed its secular bearish trend as US interest rate hikes from the Fed are slowing down in 2023 with inflation showing signs of stabilization.

EUR: Fragile. The ECB has been slower to raise rates than the Fed, while Eurozone inflation remains high. The EURUSD broke above 1.05 in anticipation of some type of resolution in Ukraine in the months ahead. The euro will likely remain fragile until there is a ceasefire in Ukraine. We note the euro has been underpinned by the ECB interest rate hiking program, which will continue in 2023. Main risk: if the Russian army crosses the Belarus border, which is 150km north of Kiev, EURUSD could drop fast towards 0.90.

GBP: Economic growth concerns. The pound is negatively affected by the war in Europe as well. In addition, the UK economy is burdened by high inflation and weak growth, which will weigh on the pound in 2023.

RMB: Rebound – USDRMB down reversal. The USDRMB broke below 7 and continues to drop as US interest rates are stabilizing and China is quickly re-opening for business in 2023. An important point to note is that the PPP (Purchasing Power Parity) of USDRMB is 4.8 compared to a spot rate 6.8. The PPP is a fundamental economic pull-back force that, just like gravity, cannot be escaped. PPP is the USDRMB exchange rate equilibrium that is based on the price of goods in the two largest world economies. This imbalance is well reflected in the trade balance that is close to an excess of USD 80bn on average per month in favor of China versus the US. Consequently, we expect a rebound of the RMB (lower USDRMB) during 2023.

JPY: Stuck at a depressed valuation level until Bank of Japan (BoJ) exits the zero-rate policy. The main catalyst for the JPY to exit the current depressed valuation level would be the end of the zero-interest-rate policy from the BoJ. Its base daily interest rate is still at -0.10%. The USDJPY declined from 150 to stabilize above 130 as markets prepare for an end to Japan’s negative interest rate era.

  • Bonds & interest rates: inverted yield curve anticipating recession

In Western economies, interest rates went up fast in 2022. It caused the sell-off of interest rate sensitive assets such as bonds, equities, and real estate. Rates were steady in China in 2022 at around 2% in the short end (below 1 year) and 3% in the long end (above 10 years). Western short-term interest rates rallied the most as their levels are set by central banks, which hiked rates by 450bps in the US and 200bps in Europe from close to zero at the beginning of 2022.

The long end of the curve (i.e. 10 years and above) reflects the anticipation of growth and inflation, which are both expected to decline in 2023. In the US, the yield curve is inverted as short-term interest rates remain elevated close to 5% and the 10-year rate is at 3.50%, suggesting a possible recession in 2023. As inflation is stabilizing globally, most of the rate hikes have been achieved in 2022 and the expected rate hikes by central banks until mid-2023 are already priced into the bond yields. Consequently, going forward, we anticipate less volatility in the government and investment grade bond market. Investment grade bond yields in USD can already deliver 6% net with a duration of 2 years and above. In our opinion, this is the safest income opportunity since 2000.

  • Commodities: expected lower price normalization in 2023

The commodity markets were volatile in 2022, with energy and food prices rallying in the first semester of 2022 due to the aftermath of the Covid-related supply chain disruptions and the war in Ukraine, which started in February. Because of interest rates rising in 2022 and growth declining, energy and food related commodities reverted and sold off in the second semester of 2022. As a result, oil is almost flat for 2022. Because Europe and the US are likely to enter into recession, energy, food, and the broader commodity markets are expected to trade sideways or lower in 2023.


  • Russia-Ukraine war escalation: A worsening of the war would affect Europe the most, and if the Russian army crosses the Belarus border, which is 150km north of Kiev, EURUSD could drop fast towards 0.90. In addition, the US and Asia could suffer a stronger economic slowdown amid surging commodity prices.
  • President Biden’s loss of power: The US president’s mental and physical health is a cause for concern. A disruption of the US presidency could generate impactful instability domestically and globally.
  • Covid variants: New waves of infections caused by Covid variants could further weigh on the economic growth outlook.
  • US-China tensions: US-China friction remains strong, with increasing tension around Taiwan and the South China Sea. In addition, the US is maintaining pressure on Chinese companies listed on US stock exchanges by implementing stricter rules targeting Chinese firms, effectively leading to the delisting of Chinese stocks from US exchanges in favor of Hong Kong and Shanghai.
  • Increasing defaults for High-yield corporate bonds: The realized default rate of High-yield bonds in Western economies has been low (<2%); however, slowing economic growth combined with higher financing rates may result in higher corporate defaults.


  • Income from safe cash deposits: Cash can be safely placed in cash deposits and earn several percentage points of annualized net interest, e.g. over a period of 6 months: USD 5%, EUR 2.25%, GBP 3.5%, RMB 2%.
  • Income from Investment Grade bank bond issuers: Banks are implicitly protected by central banks and their bonds have already mostly integrated the ambitious interest rate hiking cycle. Investors can enjoy a substantial yield from a diversified bank bond portfolio of 2-year duration: USD 6%, EUR 3%.
  • Japanese yen: The JPY is extremely undervalued, close to a 30-year low. A change in BoJ’s monetary policy could trigger a re-appreciation of 10% to 15%.
  • Nuclear energy: We believe the nuclear sector will be instrumental in the world’s decarbonization efforts. To achieve fossil fuel reduction targets, the nuclear power industry’s safety standards need to be brought to the next level, for instance by using new technology to recycle uranium. New “green” nuclear energy is the number one priority of President Macron in France, while being high on the agenda in the US and China, which will build 150 nuclear power plants in the next 15 years.
  • Defense and security: The war in Ukraine has triggered massive investment in military defense and the overall security sector – including cyber, food, energy and semiconductor supply security – in Europe and around the world.