The last year has been defined by a stronger dollar, higher rates, and flatter curves. As we head into 2023, inflation seems to be turning a corner globally and messaging from central banks is as nuanced and complicated as ever. In this piece we will lay out macro scenarios to watch in the year ahead. Some are more likely than others, but each would have far-reaching impacts on investors and macro risk hedgers.
At Validus, we always try to avoid ‘sitting on the fence’ without having a clear directional bias. Frustratingly however, that is exactly the scenario we currently find ourselves in. Overall, our base case expectation for a weaker dollar remains unchanged from recent months. However, given the magnitude of the move over the past quarter, our conviction over further dollar weakness is lower than it was three months ago.
In the UK, the BoE has prepped markets for the longest recession since the 1920s with 8 quarters of declining growth expected. In the Eurozone we have politicians lamenting the ECB for hiking too quickly, and the ECB remaining resolute that further hikes are on the table. Should we see a merging of expectations – worse than expected in the US, better in the EU and UK – we believe there is a more room for the USD to weaken against the euro and the pound. Add to this that the USD remains markedly overvalued against both currencies, looking at PPP measures we see it some 13-16% overvalued, historically these valuations haven’t persisted for extended periods – another reason to be cautious on continued USD strength.
After a challenging 2022, investors have been left bruised by turbulent markets. However, looking ahead to 2023, there could be several factors that could drive a more stable outlook – though geopolitical and digital risks should not be underestimated:
As we enter a new world of tight money and inflationary pressures, many are predicting a ‘private capital winter’, where fundraising is challenging, deal flow is tepid, and valuations come under sustained pressure. While it is undeniable that the dramatic shift in macro conditions will create challenges for the private capital sector, our view is that all is not as bleak as conventional wisdom suggests – indeed, there are some areas which may well benefit from this new world of higher rates. Volatility, after all, creates opportunities as well as threats.
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