Top Macro Themes and Factors Affecting Global Markets in October

Introduction:

In the multifaceted world of global finance and economy, 2023 stands as a year of pivotal change, evolution, and challenges. As the reverberations of past geopolitical events and pandemics continue to shape the economic terrain, new macroeconomic trends emerge, sculpting the pathways for markets, commodities, and currencies. These trends, marked by regional nuances and broad global shifts, influence everything from individual investment decisions to overarching fiscal policies of nations. Moreover, with central banks worldwide adapting and strategizing to keep pace with these shifts, the stakes have never been higher. Delving deep into this intricate dance of numbers, policies, and strategies, this article provides an expansive look into the driving forces of the global economy this year. Whether you’re an investor, a policymaker, or simply someone keen to understand the global economic narrative of 2023, this exploration offers invaluable insights into the forces at play and their potential ramifications.

Top Macro Factors

• Global Economic Slowdown: There is a sharp slowdown in global growth, with nuances existing across different regions. The US economy is expected to slow to 0.3% over 2023, and the unemployment rate is expected to rise. Developed Europe is also expected to see a contraction in output.
• Persistent Inflation: Inflation is expected to ease slowly, leading to a continuation of tight monetary policy. While leading indicators such as commodity prices, shipping rates, and inflation expectations point to weaker price growth, it will take a while for headline inflation to reach central bank targets.
• Fiscal Policy Tightening: Government spending is expected to fall by 1.0% of global GDP. Among major economies, the most tightening is expected in China, Germany, Russia, and the US.
• US Dollar Fluctuations: The US dollar is expected to struggle to maintain its uptrend over 2023 and instead will likely peak. The major driver of the US dollar in 2022 was an increasingly hawkish Fed as well as rising geopolitical risk.
• Central Bank Activity: Central banks’ actions, particularly those of the Federal Reserve, Bank of England, and the European Central Bank, will be key to watch in 2023. These banks have aggressively hiked rates throughout the year, but lower inflation readings have allowed them to step down the hikes.
• ESG Practices in FX: The popularity of FX hedging strategies linked to sustainability targets is increasing. Trading desks are ensuring they are trading with counterparties that have strong ESG practices in place.
• FX Market Shifts: The FX market saw a large shift toward listed products, such as FX futures in 2021 and 2022, and this trend looks set to continue into 2023 and beyond.
• Emerging Markets Vulnerability: The Middle East Crisis, Russia-Ukraine War, energy crisis, reopening of China’s economy, trade wars, and supply chains are all areas to keep an eye on in 2023. Emerging market currencies could potentially become more vulnerable.
• Commodity Prices: Commodity prices are expected to remain elevated in 2023, driven by Mainland China’s improving economy and policies that will boost domestic demand for commodities. However, most commodities are expected to average lower on a year-on-year basis.

These themes are shaping the global markets and their impacts are being felt across various sectors. It’s important for investors and policymakers to keep these themes in mind as they navigate the current economic landscape.

Middle East Crisis and Global Market Impact:

The ongoing crisis in the Middle East, particularly the escalating conflict between Israel and Hamas, has the potential to significantly impact the global economy. The potential impacts can be broadly categorized into three areas: oil prices and energy supply, inflation and interest rates, and geopolitical instability leading to deglobalization.

Oil Prices and Energy Supply

The Middle East is a crucial supplier of energy and a key shipping passageway. Any conflict in the region can disrupt oil production and supply, leading to higher oil prices globally.

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The International Monetary Fund (IMF) suggests that a 10% increase in oil prices could reduce global output by about 0.15% in the following year and increase global inflation by about 0.4 percentage points. If the conflict draws in neighboring countries, the situation could worsen, potentially leading to a surge in oil prices.

Inflation and Interest Rates

Higher oil prices can lead to increased inflation, which in turn could cause central banks around the world to raise interest rates to control inflation. The Federal Reserve, for instance, has been closely monitoring the situation, as higher oil prices could affect their outlook of gradually easing inflation. However, the U.S. could be an exception in this scenario, as foreign investors might consider it a safe haven during global conflict, leading to a potential decrease in interest rates and a strengthening of the dollar.

Geopolitical Instability and Deglobalization

The crisis in the Middle East adds to the existing geopolitical instability, which could lead to a further slowdown in the global economy. The conflict could also exacerbate the trend of de-globalization, as it might lead to reduced trade cooperation, less information sharing, less technology sharing, and fewer financial-market linkages. This could potentially slow down global GDP growth and act as a restraint on global economic activity.

In conclusion, the crisis in the Middle East could have significant impacts on the global economy, particularly through disruptions in oil prices and energy supply, increased inflation and interest rates, and heightened geopolitical instability leading to de-globalization. However, the exact implications will depend on how the situation evolves over time.

Macro trends Affecting Global Markets:

The top three macroeconomic trends affecting the global markets in October 2023 are:

1. Slow and Uneven Global Economic Growth: The global economy continues to recover from the pandemic and geopolitical shocks, such as Russia’s invasion of Ukraine, but the growth remains slow and uneven. The International Monetary Fund (IMF) forecasts that global growth will slow from 3.5% in 2022 to 3% in 2023 and 2.9% in 2024. This is well below historical averages, indicating a sluggish global economy. The World Bank also projects a slowdown in global growth to 1.7% in 2023. The Conference Board forecasts a global real GDP growth of 2.9% in 2023, slightly down from 3.3% in 2022, and expects further slowing to 2.5% in 2024.
2. High Inflation: Inflation remains uncomfortably high across the globe. Near-term inflation expectations have risen markedly above target, and bringing these expectations back down is critical to winning the battle against inflation. While headline inflation has peaked in most economies, core inflation (excluding volatile items such as food and energy) has proven stickier and has not decisively peaked in many economies. The World Bank also expects global inflation to moderate but remain above pre-pandemic levels.
3. Volatility in Commodity Prices: Commodity prices could become more volatile due to increasing climate and geopolitical shocks. This represents a serious risk to the global economy. For instance, between June and September 2023, oil prices increased by about 27% before falling back more recently by about 8%. Food prices remain elevated and could be disrupted further by an escalation of the war in Ukraine. The IMF also highlights that geo economic fragmentation has led to a sharp increase in the dispersion in commodity prices across regions, including critical minerals, which could cause serious macroeconomic risks going forward.

These trends are expected to have significant implications for both developed and emerging economies. For instance, growth prospects have weakened since the global financial crisis, especially for emerging markets and developing economies. The World Bank also highlights that the sharp downturn in growth is expected to be widespread, with forecasts in 2023 revised down for 95% of advanced economies and nearly 70% of emerging market and developing economies.

FX Market Shifts:

The shift towards listed products in the foreign exchange (FX) market, such as FX futures, has been a significant trend in recent years, particularly in 2021 and 2022, and is expected to continue into 2023 and beyond. This shift is driven by several factors, including regulatory changes, cost considerations, and the desire for greater transparency and efficiency.

One of the main drivers of this shift is the increase in global regulations, which has led to higher costs for over-the-counter (OTC) derivatives trades. As a result, foreign exchange investors are moving more of their OTC derivatives trades to lookalike products on exchanges to avoid these higher costs and to benefit from the increased transparency that these exchanges provide. This shift is also driven by the need to manage rising compliance costs and the desire to leverage positions more effectively, particularly for asset managers and hedge funds.

The shift towards listed products is also being driven by the increasing costs of margin and collateral. Higher interest rates make posting margin more expensive, which has led to a greater interest in clearing trades through an exchange, where the new margin rules exempt cleared trades. This shift is particularly acute for buy-side firms that have to post margin for the first time and incur the operational, legal, and custody costs of setting up margin facilities, as well as the capital costs of posting margin.

The trend towards listed products is reflected in the trading volumes of these products. For example, the average daily volume of CME’s listed FX futures and options market increased from $76 billion in 2021 to $85 billion in 2023. This indicates that more investors are using exchange-traded derivatives to replace OTC trades where possible.

However, not all investors see the need to shift to listed products, even with higher costs. Some derivative products do not have a cleared alternative, which limits broader adoption. Furthermore, exchange-traded futures contracts have a fixed settlement date relative to OTC forwards, which makes them unattractive to some investors. There are also concerns that pushing more trades to the clearinghouse will consolidate risk rather than reduce it.

In conclusion, the shift towards listed products in the FX market is a significant trend driven by regulatory changes, cost considerations, and the desire for greater transparency and efficiency. However, the extent of this shift and its impact on the overall FX market will depend on a variety of factors, including the evolution of global regulations, market conditions, and the preferences and strategies of different market participants.

Central Bank Actions:

In 2023, the Federal Reserve, Bank of England, and the European Central Bank have been actively managing their respective economies through aggressive rate hikes. However, lower inflation readings have allowed them to moderate the pace of these hikes.

Federal Reserve

The Federal Reserve held interest rates steady, indicating that it expects one more hike before the end of the year and fewer cuts than previously indicated next year. The Fed funds rate was kept in a targeted range between 5.25%-5.5%, the highest in some 22 years. The rate influences what banks charge each other for overnight lending and also impacts many forms of consumer debt. The Federal Reserve has also been reducing its bond holdings, a process that has cut the central bank balance sheet by some $815 billion since June 2022.

Bank of England

The Bank of England’s Monetary Policy Committee (MPC) increased the Bank Rate by 0.25 percentage points, to 5.25% in August 2023. The MPC’s projections for activity and inflation are based on a market-implied path for the Bank Rate that rises to a peak of just over 6% and averages just under 5?% over the three-year forecast period. The MPC will continue to monitor closely indications of persistent inflationary pressures and resilience in the economy as a whole, including the tightness of labor market conditions and the behavior of wage growth and services price inflation.

European Central Bank

The European Central Bank (ECB) raised the three key ECB interest rates by 25 basis points in September 2023. The rate increase reflects the Governing Council’s assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation, and the strength of monetary policy transmission. The ECB staff have lowered their economic growth projections significantly, expecting the euro area economy to expand by 0.7% in 2023, 1.0% in 2024, and 1.5% in 2025.

In conclusion, the central banks’ actions in 2023 have been characterized by aggressive rate hikes to manage inflation and stimulate economic growth. However, lower inflation readings have allowed them to moderate the pace of these hikes. The central banks continue to monitor economic indicators closely to inform their future monetary policy decisions.

Conclusion:

The tapestry of global economic shifts in 2023 paints a picture of an interconnected and intricate landscape. With challenges such as uneven economic growth, inflationary pressures, and evolving central bank policies, the world is grappling with uncertainties and potential opportunities. As these trends evolve, it’s imperative for investors, policymakers, and market participants to remain agile and informed. By comprehending the subtleties of these economic dynamics, one can better anticipate future trajectories and make strategic decisions in the ever-changing global marketplace.

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