Global financial markets remained turbulent in the first half of the year

　　The contraction of monetary policies in developed countries exacerbates the volatility of the global financial market. In 2022, affected by the rapid rise of domestic inflation, the central banks of the United States, the Eurozone, and the United Kingdom will be forced to rapidly raise interest rates and shrink their balance sheets. In 2022, the Federal Reserve will raise interest rates seven times in a row from March to December, with a cumulative increase of 425 basis points. Such a rapid rate hike and shrinking balance sheet is unique since the early 1980s. During the same period, the European Central Bank raised interest rates four times in a row from July to December, accumulatively raising interest rates by 250 basis points. The Bank of England also announced a 50 basis point rate hike on December 15, 2022, the ninth consecutive rate hike since December 2021. The collective interest rate hikes by the central banks of developed countries led to a rapid rise in short-term and long-term interest rates, exacerbating the turmoil in the global financial market (Figure 1). On the one hand, all kinds of asset prices (whether risk assets or safe-haven assets) including the stock market, bond market, commodities, and gold have fallen significantly; The sharp appreciation of market currencies has triggered different forms of financial crises in some emerging market countries (such as Sri Lanka, Pakistan, Lebanon, Turkey, Argentina, Egypt, Zambia, and Ghana).
Figure 1: Changes in policy interest rates in the US, EU, and UK

Source: CEIC. Drawing: Yan Bin

　　Russia-Ukraine conflict pushes up global commodity prices. The Russia-Uzbekistan conflict that broke out on February 24, 2022 has exceeded market expectations in terms of the intensity and duration of the conflict. Since both Russia and Ukraine are the most important commodity suppliers in the world (Russia exports almost all commodities and Ukraine mainly exports agricultural products), the conflict between the two countries has exacerbated the shortage of global commodity supply, which has significantly pushed up prices including energy and food. Commodity prices included.
　　After the outbreak of the Russia-Ukraine conflict, the United States and its allies (mainly NATO members) imposed comprehensive economic and financial sanctions on Russia. For example, the European Union and the United Kingdom have imposed import restrictions and price caps on Russian oil and gas exports. This move caused a sharp drop in Russian oil and gas exports to the EU and the UK, which directly pushed up the domestic inflation level of the latter. As another example, the United States and its allies not only froze Russia’s foreign exchange gold reserves, but also excluded a large number of Russian financial institutions from the SWIFT (International Fund Settlement System) clearing system. The outbreak and continuation of the Russia-Ukraine conflict means that global geopolitical conflicts will intensify, which may replace the financial crisis as the most important risk facing the world economy in the next stage. Rising geopolitical conflict usually means high commodity prices. For example, Brent crude oil futures prices in 2020, 2021, and January-November 2022 are $43, $71, and $100 per barrel, respectively (Figure 2).
Figure 2: Brent Crude Oil Futures Prices

Source: CEIC, 1967=100
Figure 3: The global economy will initially form a stagflation pattern in 2022

Source: CEIC

　　The stagflation pattern of the global economy has initially taken shape. In the 1970s and 1990s, the global economy fell into stagflation twice (Figure 3). It is worth mentioning that the emergence of these two stagflation patterns are related to geopolitical conflicts. For example, the Middle East war broke out in the 1970s, and the Gulf War broke out in the early 1990s. According to the IMF (International Monetary Fund) forecast in October 2022, the global economic growth rate in 2022 will be about 3.2%, while the global inflation rate may exceed 6%, which means that the global economy in 2022 has initially fallen into a stagflation pattern. The impact of the COVID-19 pandemic on global economic growth, steep interest rate hikes in developed countries exacerbating the prospect of a global economic recession, and frequent financial crises in emerging market countries affecting economic growth, all these factors will exacerbate the “stagnation” of the global economy. The reorganization of the global supply chain production chain triggered by the new crown epidemic, the unprecedented loose macro policies implemented by developed economies after the outbreak of the new crown epidemic, and the impact of the Russia-Ukraine conflict on the global commodity market will all aggravate the “inflation” side of the global economy . It can be said that neither policy makers nor market investors are willing to face the pattern of stagflation. For policymakers, traditional demand management policies (fiscal and monetary policies) alone are difficult to get the economy out of stagflation. For market investors, it is difficult to find assets with yields exceeding the inflation rate in the era of stagflation.

Federal Reserve headquarters. Figure/Faxin
The deep reason behind

　　Demand factors and supply factors together push up global inflation. The reasons for the current round of high inflation in developed economies are both at the demand level and at the supply level. From the perspective of demand, after the outbreak of the new crown epidemic, the United States, the euro zone and the United Kingdom have implemented extremely loose fiscal and monetary policies to boost economic growth and stabilize financial markets, and these loose policies generally act more on the demand side. rather than the supply side. This has created a situation in which demand recovery is significantly faster than supply recovery after the epidemic, and a situation where supply exceeds demand will inevitably mean an increase in the inflation rate. From the perspective of supply, on the one hand, the COVID-19 epidemic has significantly impacted the global production network and transportation system, which once caused supply-side contraction, thus pushing up the level of inflation; This created a new supply-side shock and indirectly pushed up global inflation by pushing up commodity prices. Judging from the recent inflation trends in developed countries, inflation driven by commodity prices is transforming into inflation driven by service prices, and the tight labor market is bringing wage growth. This means that the duration of this round of inflation in developed countries may exceed previous market expectations.

　　Global geopolitical conflicts have entered a period of high incidence. Since the outbreak of the global financial crisis in 2008, economic growth in many countries has stagnated on the one hand, and asset prices have risen rapidly on the other, which has exacerbated the imbalance in domestic income and property distribution. In the context of economic distress, asset damage, and class mobility decline, domestic politics in many countries have fallen into a state of tension or even turmoil. In order to ease domestic political tensions, politicians deliberately divert domestic public sentiment to the outside world, which intensifies international geopolitical conflicts. As shown in Figure 5, from 2008 to the present, the global economic policy uncertainty index, which reflects uncertainty, has generally shown a continuous upward trend. As the global economic structure switches from “long-term stagnation” to “stagflation”, the situation of intensified geopolitical conflicts will not ease, but may continue to worsen. The Russia-Ukraine conflict that broke out in 2022 is the most typical example. In addition, the current geopolitical situation in the Middle East, Central Asia, and East Asia is not peaceful. With the Democratic Party of the United States losing Congress in the 2022 midterm elections, the Democratic Party will continue to push forward in the next two years. 此反受问问猓Yu Yunhui does not swim adorned.
Figure 5: Global Economic Policy Uncertainty Index Trend

Source: CEIC

　　The tide of globalization is ebbing, and the trend of regionalization and conglomeration is intensifying. From the 1980s to the 2010s, the momentum of economic and financial globalization has greatly improved the efficiency of global resource allocation, and also brought about an era of high growth and low inflation (the Great Moderation Era). However, with the emergence of a long-term stagnation pattern after the outbreak of the global financial crisis in 2008, economic, social and political contradictions within countries have intensified, conservatism, isolationism and unilateralism have risen one after another, and voices of criticism, opposition and resistance to globalization have gradually sounded. 2016 was a symbolic year when globalization encountered headwinds. The British referendum passed the resolution to leave the European Union and Trump won the US general election. The outbreak of Sino-US economic and trade friction in 2018 and the outbreak of the new crown epidemic in 2020 have both exacerbated the ebb tide of globalization (Figure 6). At present, whether it is in the fields of global production network, economy and trade, finance, currency, etc., there is a trend of rising regionalization and grouping. From globalization to regionalization and conglomeration, this means that the ability to effectively allocate resources on a global scale has declined, which in turn means that the efficiency of global production and transactions has decreased and costs have increased. In fact, the ebb tide of globalization is also the deep-seated reason why the world economy will turn to face inflationary pressure in 2022.
Figure 6: The growth rate of global trade has declined in recent years

Source: CEIC
Figure 7: US 10-year Treasury yield and US dollar index trend

Source: CEIC
Global Macrofinancial Outlook to 2023

　　In 2023, the overall global economic growth rate will drop. In 2020, affected by the outbreak of the new crown epidemic, the growth rate of global GDP (gross domestic product) will drop from 2.8% in 2019 to -3.1%. In 2021, due to the joint impact of the low base and the economic recovery after the epidemic, the global GDP growth rate will rebound to 6.0%. In 2022, due to the contraction of monetary policies of major developed economies and the weak growth rate of major emerging markets, the growth rate of global GDP will decline significantly. According to the forecast of the IMF in October 2022, the global GDP growth rate in 2022 and 2023 will be 3.2% and 2.7%, respectively. Among them, the GDP growth rate of developed economies will drop sharply from 2.4% in 2022 to 1.1% in 2023, and the GDP growth rate of emerging markets and developing economies will remain at 3.7% in both 2022 and 2023. The normalization of macroeconomic policies in advanced economies, especially the contraction of monetary policy, will significantly affect the economic growth of these economies in 2023. By contrast, the euro zone and the UK are also suffering from rising energy prices triggered by the Russia-Ukraine conflict. According to the IMF’s forecast in October 2022, from 2022 to 2023, the GDP growth rate of the United States will drop from 1.6% to 1.0%, the euro zone will drop sharply from 3.1% to 0.5%, the UK will drop sharply from 3.6% to 0.3%, and Japan will drop from 3.6% to 0.3%. 1.7% edged down to 1.6%. Growth prospects for emerging market economies vary. First of all, the economic growth rates of China, India and ASEAN are relatively optimistic. According to the latest forecast of the IMF, the economic growth rates of the above three economies in 2023 will be 4.4%, 6.1% and 4.9% respectively. Secondly, driven by the sharp rise in commodity prices, commodity exporting countries will experience strong growth in 2022, and as commodity prices stabilize or even fall, these economies will also face a slowdown in growth in 2023. Thirdly, Russia, which is deeply involved in the Russia-Ukraine conflict, will continue to face economic recession. According to the latest forecast of the IMF, the economic growth rate of Russia will be -3.4% and -2.3% in 2022 and 2023, respectively. The author believes that in 2023, China will be the main engine leading global economic growth, and the global growth pattern in 2023 will show a situation of “rising in the east and declining in the west”.
　　The Fed’s interest rate hike cycle will last until the first half of 2023, and the long-term interest rate and the dollar exchange rate in the United States are expected to decline significantly in the second half of 2023. The core of the judgment on the trend of the global financial market in 2023 depends on the judgment on the trend of long-term interest rates in the United States. The core of the judgment on the long-term interest rate trend in the United States depends on the judgment on the inflation rate in the United States. The author believes that although the year-on-year growth rate of the CPI (Consumer Price Index) in the United States has reached a peak of 9.0% in June 2022, considering the wage pressure in the labor market, the general continuous rise in service prices, and the still high housing prices, etc., The US inflation rate will remain at a high level for a certain period of time, for example, it will continue to be higher than 4%-5% in the next six months. Based on the above forecast of the trend of the US inflation rate, the author believes that although the Fed will reduce the rate of each rate hike, the current round of the Fed’s rate hike cycle may last until the second quarter of 2023. After the federal funds rate peaks (probably at 5.0%-5.5%), the Fed will keep interest rates at that level for a certain period of time until inflation falls significantly. If the above judgment is correct, then the author’s prediction is that both the US long-term interest rate and the US dollar index may peak in the first or second quarter of 2023. It is difficult for the top of this round of U.S. 10-year Treasury yields to exceed 4.5%, and the top of the U.S. dollar index may be around 115-118. In the first half of 2023, the U.S. long-term interest rate and the U.S. dollar exchange rate will fluctuate at high levels in both directions. By the second half of 2023, long-term U.S. interest rates and the U.S. dollar are expected to decline significantly.

Global financial markets will remain in a period of volatility in the first half of 2023. As mentioned earlier, the global financial market in 2022 will be very volatile, rooted in the rapid rise of long-term interest rates in the United States and the rapid appreciation of the U.S. dollar index. The rapid rise in risk-free rates weighed on both risk assets and safe-haven assets. In the second half of 2022, we see the price decline of global stocks, bonds, commodities, gold, and the significant decline of most currencies against the US dollar. Although the global stock market, bond market and bulk commodity prices have rebounded recently, the author believes that the foundation of this wave of rebound is not solid. Once the U.S. inflation rate falls below expectations in the short term, U.S. long-term interest rates and the U.S. dollar index may rebound again. In other words, many financial indicators will show bilateral fluctuations in the next six months, and it is difficult to form a unilateral trend. In fact, in the first half of 2023, on the one hand, major developed economies will continue to raise interest rates and shrink their balance sheets, and on the other hand, the pressure of global economic recession will intensify. Therefore, whether it is the global financial market, or emerging markets and developing countries , in the first half of 2013 will usher in a period of difficult days. In addition, it is worth mentioning that the Bank of Japan recently began to adjust its yield control policy (YCC, Yield Curve Controlling), the yield of 10-year Japanese government bonds has risen from 0.25% to about 0.5%, which means that the last part of the global Low-interest funds began to disappear, which may lead to the end of the carry trade and new financial shocks.
Asset Allocation Suggestions for 2023
1. The volatility of U.S. stocks will remain at a high level, and we are full of vigilance against the potential decline of U.S. stocks

　　At present, there are large differences of opinion in the market on the trend of the US stock market in 2023. The author believes that the adjustment of US stocks in 2022 is not sufficient compared with history. For example, U.S. stocks experienced a wave of 20% declines in 2020 because the Federal Reserve tightened monetary policy between 2015 and 2018. At that time, it took the Fed four years to raise interest rates nine times, accumulating 225 basis points. In 2022, the Fed will raise interest rates seven times in ten months, accumulating 425 basis points. In 2022, the deepest adjustment in U.S. stocks will be about 20%. To sum up, the author believes that the current round of US stock market adjustments is likely not over yet. At least in the first half of 2023, the volatility of U.S. stocks will remain high, and the possibility of another sharp drop in U.S. stock indexes cannot be ruled out.
2. The global financial market will remain turbulent in the first half of 2023, and cash is king is still a better strategy

　　As mentioned earlier, in 2023, on the one hand, the central banks of developed countries will continue to raise interest rates and shrink their balance sheets, and on the other hand, the shadow of global economic recession is expected to intensify. Such an environment is not conducive to the performance of financial markets. Long-term risk-free interest rates and the US dollar exchange rate are expected to continue to consolidate at high levels, which means that both risk assets and safe-haven assets will continue to be under pressure. Although the inflation rate will continue to consolidate at a high level, the peak has passed after all. In this context, at least in the first half of 2023, it is a good choice to increase the proportion of cash holdings, which means waiting for asset prices to adjust to better opportunities before starting. It is worth mentioning that gold, which has fallen to US$1600-1700 per ounce, has the value of medium and long-term fixed investment in my opinion.
3. Be wary of more financial crises in emerging markets and developing countries

　　2022 is already a turbulent year for emerging markets and developing countries. As mentioned earlier, many countries have experienced financial crises in the form of currency crises and sovereign debt crises. In 2023, the downward pressure on the global economy will increase, financial conditions will remain quite tense, and commodity prices are expected to fall from high levels, which will increase the possibility of financial crises in certain emerging markets and developing countries. Of particular concern is the sustainability of the sovereign debt of African heavily indebted poor countries. Therefore, investors should avoid foreign exchange and sovereign bond investments in some emerging markets and developing economies with strong financial vulnerabilities in 2023.