Investment Outlook 2023: Upcoming reset for the global economy

The global economy is headed for a fundamental reset

For many years, geopolitics played a minor role in the global economic and financial outlook. These were the times of stable international relations and a relatively high degree of multilateral trust among countries. Though crises did occur, most of them were for financial reasons.

That world order gradually started to falter in recent years and lost its grip completely in 2022 when war struck in Ukraine. As a result, geopolitics took center stage once again. That is likely to not only have a significant impact on the global economy and the financial markets, but to also reset international relations and commerce for many years to come. This has implications for short-, medium-, and long-term growth, price prospects, and monetary and fiscal policy. The reset could potentially lead to sizable shifts in the global monetary system with reverberations in financial markets.

Impact 1: New world order

The world of multilateralism and strong mutual trust between countries and governments came to an end – or at the very least paused – in 2022. Deep and persistent fractures emerged in the geopolitical world order, giving rise to a multipolar world that is likely to last for years. The global West – which includes Western developed countries and allies – has drifted away from the global East, i.e. China, Russia, and their allies, in terms of core strategic interests. The global South, including Brazil, Russia, India, China, and most developing countries, is reorganizing to pursue its own interests.

Impact 2: Out with the old monetary regime

COVID-related disruptions of global supply chains, more decisive climate policy action, and a full-fledged energy crisis and food price shock in the wake of the Ukraine war led to a new regime of elevated inflation. As a result of these challenges, central banks tightened monetary policy in bigger increments and more swiftly than expected. This brought an end to "lowflation" – a phase of low or even negative interest rates.

Central banks are signaling further rate hikes to reduce demand and create slack in the labor market. This has prompted Credit Suisse to increase its forecasts for central bank policy rates in all major economies except China. We now expect the fastest pace of tightening on a 12-month basis and of the largest magnitude globally since 1979. Although the pace of tightening is expected to peak by the end of 2022, no developed market central banks are forecast to cut interest rates in 2023, as they are focused on actual rather than expected inflation.

Impact 3: Growth outlook dims

The outlook for GDP growth has dimmed: Recessions are forecast in the euro zone and the UK as is a growth recession in China. These economies will likely bottom out by mid-2023. After that, a slow recovery should begin, assuming that the US manages to avoid a recession.

Potential growth is also likely to be lower over the next five years. This is related to the fact that the new geopolitical environment allows for less international cooperation on technological innovation. It will also lead to less free movement of human talent and hence smaller productivity gains.

Impact 4: US dollar reaches its peak

In terms of foreign currencies, the USD should enjoy continued support as long as the US Federal Reserve (Fed) remains on its hawkish course. To prevent currency depreciation from exacerbating imported inflation, the European Central Bank will need to keep pace with the Fed. Moreover, continued USD strength is likely to pull capital from emerging markets.

The real trade-weighted USD is already at its strongest level since 1985. Therefore, it seems reasonable to expect the currency to peak and potentially lose some ground in the latter part of 2023. Yet this will likely require the Fed to signal an end to its tightening and some signs of economic recovery outside the US.

Impact 5: Potential reset for the global monetary system

In the longer term, however, the resetting of international relations may lead to new developments in the global monetary system. The USD-based monetary system had never been challenged in the post-World War II era until the USD lost its neutrality in 2022, when the Fed and other central banks froze Russian central bank reserves. Additionally, the new multipolar world and the resetting of international trade may well, over time, lead to the emergence of two parallel monetary systems: the current USD-based system and a yet-to-be-conceived alternative system bypassing the USD.