Economic fundamentals a bigger 2023 concern for markets than rate shocks: GIC

ECONOMIC fundamentals and liquidity shocks are a bigger concern for markets than rapidly rising interest rates in 2023, according to GIC’s chief economist Prakash Kannan.

 “Our view is roughly on the interest rate shock, you’re probably about 85, or 90 per cent done, and this is with regard to both what’s priced into the market, but also in relation to where we see inflation dynamics,” he said during the Official Monetary and Financial Institutions Forum (OMFIF) Asia Forum on Thursday (Dec 8).

However, he added that they are still cautious as interest rates are just one of three categories of shocks in the markets. The other two shocks – involving the real economy and liquidity – have yet to fully play out. 

“These last two elements are what I’m particularly worried about for 2023,” said Dr Kannan in response to a question from OMFIF’s chief executive John Orchard on the financial markets and the US economy. 

“The real economy, I think, actually has been relatively resilient, but we think that is going to turn and the bulk of it is going to be felt in 2023,” he said. 

The possibility of interest rates remaining at elevated levels for longer is also another reason for caution.

“You could make a credible argument that inflation has peaked, but where we are a bit more cautious about is that even though it has peaked, we think it’s likely to be a bit more persistent,” Dr Kannan noted.

While inflation may come down, the levels above most central banks targets means that there is still pressure for keeping rates higher for longer, which would weigh on risk assets.

But the current environment of more normalised interest rates may be preferred by some.

Dr Kannan, who is also the sovereign wealth fund’s head of Total Portfolio Macro & Markets, Economics & Investment Strategy, noted that policymakers and long-only institutional asset managers are likely to be “quite happy to see the back of negative nominal rates”.

He said: “You are seeing a very different fixed income market; I think you are seeing some return of value, and I think both policymakers and politicians in general, would want to preserve that in some sense.”

Dr Kannan also noted that in the US equity markets, the equity risk premium – the difference between earnings yield and real interest rates – has come down, with the impact of real interest rates being the primary driver.

 “A declining equity risk premium is really not the kind of dynamic you would expect to see in a recession,” he pointed out, adding: “Going forward (with) the impact on the real economy coming through, you’re going to get earnings revisions coming down and I think that’s going to push risk premia a bit higher, so still a little bit more cautious, I think, at this point.”