Market Themes For 2023: Wages Matter

The only certainty is uncertainty. The perfect way to frame 2023. When the talking heads chatter confidently about the future, it’s easy to get sucked in. The year ahead is fraught with danger, especially for those confidently predicting the future.

The range of probable outcomes is wide and diverse, moreso now than ever. Morgan Stanley sum things up well in their 2023 outlook:

The turbulence of 2022 now weighs heavily on our investment outlook for 2023, with implications ranging from economic growth, inflation, central bank policy and interest rates to credit quality, earnings, valuations, investor sentiment and other key metrics.

One of the consensus views is that a recession is in our future. The deep inversion of the US yield curve is often a leading indicator for recessions…

However, the recession doesn’t usually materialise until the curve flattens out and ‘un-inverts’ so timing the recession using this as a tool could be tricky.

The other question is just how deep any recession would be. Goldman Sachs analysts only see a 35% chance of a US recession and actually see reasonable growth for the US economy for the year ahead.

Of course, reasonable growth could be fertile ground for inflation to hang around for longer, prompting the Federal Reserve and other major central banks to keep policy tight for longer.

What that might mean for stock markets such as the Nasdaq and growth stocks such as those in the ARKK fund is up for debate.

And of course the impact on currencies is another open question. A resurgence of global growth could see the dollar weaken further, especially if inflation slows just as growth picks up again.

In fact, JP Morgan’s view is that inflation will slow further. Under the heading “Inflation panic subsides, central banks pause”, they state their argument as follows:

Signs of slowing activity in the west, and a return to full production in China, should ease inflation through the course of 2023, with the shrinking contributions from energy and goods sectors in particular helping price pressures to moderate in the months ahead.

However, to be sure that we’re out of the inflationary woods, wage pressures also need to ease. This is where the central banks went wrong in assuming inflation would prove “transitory”, as they underestimated the extent to which labour market tightness would result in workers asking for more pay.

This is where the key to 2023 central bank policy lies. If workers continue to push for higher wages, there’s a chance that wage hikes will overtake inflation, and actually increase purchasing power for those workers who see their pay increased.

Essentially, it’s like two cars in a race. The wage car has lagged inflation, never quite catching up. Now inflation is slowing, wage rises merely need to continue at the same pace to ‘overtake’ inflation.

Can this spur the inflation car to pick up speed again? That’s one of the central bankers biggest fears for 2023…