Quarterly Outlook: Navigating the polycrisis - Part II

Recession over the next 12 months looks increasingly likely across developed markets, as tightening monetary conditions begin to put significant strains on financial systems.

Originally published on March 28, 2023 by Fidelity International
Written by Andrew McCaffery, Global CIO, Asset Management, Fidelity International


Three themes for Q2

  1. Hard vs. soft landing
  2. Corporate risks and opportunities
  3. China reopening

The outlook for 2023 focused on navigating the “polycrisis” – a confluence of pressures which Fidelity International believed could force central banks into overtightening and trigger sharp recessions. 

That polycrisis has entered a new phase. While economies had started the year with signs of resilience, the fastest rate-hiking episode in history is now taking its toll. Recession in developed markets looks the likeliest outcome. China may offer an alternative to developed markets – its reopening could yet provide respite to markets spanning East to West.

Three themes for the second quarter

1. Hard vs. soft landing

In recent weeks, investors have gone further in pricing in sharp cuts in interest rates later this year, but the U.S. Federal Reserve (the Fed) so far has stuck to its guns, worried that it must keep rates higher for longer in the face of persistently sticky inflation and hot labour markets.

Keeping rates higher for longer will increase the pressure on financial systems, and cracks are already starting to show. Fidelity International does not believe that the collapse of Silicon Valley Bank, followed by Credit Suisse, is indicative of any systemic risk in the banking system, but it could be a sign of further upheaval still to come. New stresses will appear without an easing of monetary policy, which will give the Fed reason to revise its stance. A cyclical recession over a 12-month time horizon, in which unemployment rises by 1% to 3%, is still the most likely outcome, but a more severe recession would be on the cards were the Fed to remain restrictive throughout 2023.

2. Corporate risks and opportunities

In this higher-for-longer environment, Fidelity International’s investment teams are focused on using their bottom-up research capabilities to identify names with resilient profiles. They’re looking for sectors and regions with structural tailwinds and defensive characteristics, along with attractive valuations, that present the best balance between risk and reward.

Over the longer term, the themes of sustainability, demographics and re-shoring/near-shoring continue to offer strong outperformance opportunities.

3. China reopening

If policy makers in the West are bracing for a hard landing, developments in China may offer a tonic. 

Contrary to consensus, we saw October’s Communist Party Congress as a positive turning point. Since then, China’s leaders have emphasized high-quality growth, refocusing the economy from an investment, export-driven model to domestic consumption and manufacturing. Policy makers are likely to continue prioritizing targeted easing to support some sectors, without any broad-based stimulus.

The result will be a different Chinese economy. The restructuring may lead to slower, but more sustainable, growth in the coming years.