December is traditionally the time to assess 2022, both globally and regionally, and what can be expected for the following year. Since this is such a broad subject, this column will focus our analysis on three crucial asset classes for the markets and the economy: stocks, bonds, and, of course, the US dollar.
The All-mighty Dollar
After what world currencies have been through, a logical starting point for this analysis is undoubtedly the dollar’s behavior. A helpful tool for this purpose is following the DXY index, which compares the dollar with six different exchange rates. Chart 1 shows the strengthening of the US currency between February and October, going from 96 to 114, which was a historical high for this index.
Chart 1: Own elaboration. Source: Investing
There are two primary factors behind this behavior. The first one is the fear caused by recession expectations, which was also driven by high inflation levels and by the weakening of the Chinese economy, which led to a quest for safe-haven assets. The second factor is the rate increase applied by the Federal Reserve (FED) to control price levels, which together with the appetite for safe havens has made the currency more attractive, especially in a context of war in Ukraine and economic deterioration in Europe, which has really weakened the traditional safe haven assets in that region.
By 2023, the Fed is expected to continue at some level its rate increases at a more moderate pace, at least for the first semester, and subsequently keep them up for these monetary policy decisions to have an effect on the price level. However, the latest US inflation figures show a change in the trend. Should this occur, a reduction in the dollar’s overall strength could be expected. However, the structural forces of increased risk perception are still there, and the dollar will remain sensitive.
Equities: Emerging vs. Developed Markets
In terms of equities, 2022 has not been an easy year for stocks, as the same forces mentioned earlier -inflation and rising central bank interest rates – have impacted this market. Chart 2 shows the performance of developed market equities captured in the MSCI World index and emerging markets through the MSCI EM index. While the dollar’s weakening can be seen in October following the US inflation data, a recovery in global equities can also be noted. Despite this, indexes have shown a drop of nearly 12% for developed and 20% for emerging markets, reflecting precisely the above mentioned impact.
Chart 2: Own elaboration. Source: Investing
Equity market performance will be connected to recession expectations and the overall pace of the economy, which along with inflation will affect the demand for goods and services. However, a background factor should be closely followed, particularly for highly indebted companies: the scenario of high-interest rates that will probably continue in 2023, where, even though no significant increases are expected, neither is a reduction.
Public Debt: The Risk Barometer
In regional terms, the geopolitical element has been relevant his year. It started with Chile’s Constituent Assembly, followed by Colombia’s election of its first left-wing president, and ended with Lula da Silva’s election for a new term in Brazil, completing Latin America’s shift to the left. These events have been crucial to risk perception in these countries and, together with inflationary levels, have affected the appetite for government bonds.
Chart 3: Own elaboration. Source: Investing
Chart 3 shows the yield rate behavior for ten-year bonds of Colombia, Chile, Brazil, and Mexico. Colombia’s bonds have been the most affected, showing a rate increase. Given that it is inverse to price, it presents a fall until October 2022. However, this phenomenon has been particularly interesting: record foreign purchase levels were seen in 2022 amidst this country’s worst devaluation scenario. November, for its part, has shown a marked preference for Chilean bonds, whereas in Brazil, after Lula’s election, the effect has been the opposite.
To conclude, 2023 will be a year where we may start seeing recessions, further exacerbating market risk aversion. However, the FED will undoubtedly be a crucial player in this scenario and whether it decides to raise rates and for how long, as such a signal will be transmitted to other central banks. In the same sense, there has been no significant change in the forces pushing prices up, which will continue to affect the demand for goods and services. If we add high-interest rate levels, the odds are set to continue with a high dollar.
This report was prepared by Gandini Análisis for Supra Brokers for informational purposes only and should not be construed as investment advice.
