While many commentators and central banks are dismissing the yield curve inversion, we think there is still some relevance in its signal such as the risk of an economic downturn (or recession) in the next 12-24 months, a future bear market or a policy mistake by the central banks which means future interest rate cuts. These are all valid concerns to keep in mind for 2023.

 

The US Federal Reserve appears to be coming around to the aggressive market pricing for interest rate hikes this year. US Fed member Harker said that 50 basis points hikes are not off the table in May/June. The market is pricing in a Fed funds rate over 2% by the end of the year (currently at 0.38%), which means a rate rise at every meeting this year, with at least one of those being a 50-basis point increase.

 

The Australian Federal Government released its 2022/23 budget. The main takeaways are a pre-election cash splash worth around 1% of GDP in terms of new stimulus in 2022 which will add further to inflation pressures, a much stronger economic outlook than forecast thanks to higher GDP growth, a lower unemployment rate, higher inflation and wages growth and higher commodity prices, projections for lower budget deficits in coming years. The cost of living measures (including the tax offset to low- and middle-income earners, the $250 cash payment to pensioners and welfare recipients and the halving of the fuel excise for 6 months) will lift near-term retail sales growth. The small business tax incentives should also be positive for business investment. The oppositions reply to the budget included a focus on lifting wages growth and spending on aged care.

 

Shares are likely to see continued volatility as the Ukraine crisis continues to unfold and inflation, monetary tightening, the US mid-term elections and geopolitical tensions with China and maybe Iran impact. However, we see shares providing upper single digit returns on a 6-12 month horizon as global recovery continues, profit growth slows but remains solid and interest rates rise but not too onerous levels.

 

Australian home price gains are likely to slow further with prices falling later in the year as poor affordability, rising mortgage rates, reduced home buyer incentives and rising listings impact. Expect a 10 to 15% top to bottom fall in prices from later this year into 2023-24 but large variation between regions. Sydney and Melbourne prices may have already peaked.

 

Cash and bank deposits are likely to provide poor returns, given the ultra-low cash rate of just 0.10% at present but rising through the second half of the year.