A Strong Dollar, Higher Rates, and Weaker Stocks Will Dominate 2023
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- There may be no recession in 2023, just a period of slower growth
- It will allow the Fed to keep financial conditions tight.
- Tight financial conditions mean a stronger dollar, higher rates, and stagnant stocks
The theme heading into the end of 2022 is focused on expectations for a recession in 2023. While that may be the case, it is hard to find any objective evidence of that happening, despite a few data points here and there. GDP for the third quarter was revised sharply higher recently, and the Atlanta Fed GDPNow suggests fourth quarter growth is likely to be solid.
There could be a recession in 2023, but at this point, it seems more likely that we are heading towards a period of stagnation, where growth slows materially as inflation rates stay sticky and above the Fed’s target. This probably leads to a Fed that sticks to its December FOMC summary of economic projections, keeping rates higher for longer and keeping financial conditions tight.
For financial conditions to remain tight, it means the dollar remains strong, Treasury rates stay elevated, and stocks struggle in 2023.
It doesn’t have to mean the Dollar Index climbs to a new high; the odds do not favor that now that the Bank of Japan has indicated a willingness to shift towards a more hawkish monetary policy stance, which will help strengthen the USD/JPY. But it probably also means the dollar index doesn’t come crashing down as many investors seem to be expecting.
Stronger Dollar
While this may only be a short-term viewpoint currently, the dollar index is trying to bottom between 103.70 and 106, and it has an RSI turning higher. This suggests that the dollar could rally back toward that 110 level in the weeks ahead.
USD 1-year chart
Higher Rates
Like the dollar, the United States 10-Year doesn’t have to make a new high for financial conditions to tighten; it simply needs to rise back to its highs and stay there. Like the dollar, the 10-year appears to be breaking free of a bullish reversal falling wedge pattern, indicating the rate may be heading back to its highs.
US 10-year yield Chart
A stronger dollar and higher rates will be critical for tightening financial conditions. Financial conditions had eased since the middle of October as the dollar weakened and rates fell.
Financial Conditions Chart
Stagnant Stocks
The final piece of the equation will be the equity market, and with financial conditions tight, we aren’t likely to see equities rally. It doesn’t mean they have to fall, but from a financial conditions standpoint, they can’t rally meaningfully either. If stocks rally, it will work to ease financial conditions; therefore, stocks are likely to move lower or stay range bound. The other issue is that if financial conditions are tight and work as intended, they should slow economic growth in 2023, which will likely hurt the economy and earnings.
Financial Conditions & SPX Chart
That, overall, will make 2023 a complex landscape to navigate, and with the economy probably drawing close to the no-growth phase and flirting with recession, as many predict, it may make 2023 more challenging than 2022.
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