There are really only two camps in financial markets heading into 2023.
- The group that thinks the Fed has hiked too much and the economy is going into a tough recession
- The group that thinks the economy holds up and that high rates linger
Put me in the second camp, but only in the US.
I can see the arguments for both and this is going to be a data-traders’ market.
I believe the most-important thing to understand for 2023 is how global mortgage markets work.
The US works on a 30-year fixed, which is one set payment for the entire duration of the mortgage, with no penalties for refinancing. Two years ago, those payments fell to 2.6% and even at this time last year were at 3.1%. So the vast majority of American homeowners who purchased before 2022 are locked in. So long as they don’t move, they won’t feel any pain from higher rates via their homes.
I’d even argue that Americans still haven’t fully benefited from refinancing in 2020 and 2021. As the pandemic fades, the lower payments are being redirected into long-planned travel and some people are finding they have more disposable income than ever.
At the same time, student loan rates were pinned at zero by Biden and remain there with the possibility of forgiveness still to be decided by the courts (and upside risk in 2023).
Of course, Americans still have lines of credit, auto loans and other forms of debt where they’re feeling higher rates. We will be hearing many stories this year about people who are losing cars, boats, RVs and other pandemic excesses. I worry about that but I think that so long as the vast majority of consumers continue to spend and the jobs market holds up (those two rely on each other), then the US economy will surprise to the upside in 2023.
How that feeds back into inflation is a key question for 2023 but I can envision a path where inflation undershoots in a weak economy because…
…the rest of the world is different
While the Fed’s effects on the US consumer are largely indirect, that’s not the case in much of the world.
In Australian, for instance, 60% of home mortgages are on variable rates. The remainder are on fixed terms from 1-5 years so a good chunk of those roll off annually and reset higher. It’s similar in the UK, Canada and many other countries.
The 30-year fixed mortgage shields the US consumer from the harshest direct impacts of rate hikes while homeowners in the extremely overvalued home markets in Australia and Canada are often facing monthly payments +$1000 higher than a year ago.
So while many countries have been able to track the Fed towards higher rates, they’ve hit a limit on how much they can hike and how long they can hold rates high.
So with the Fed and the RBA you have two central banks that have ostensibly done the same thing but in the real economy it’s critically different. That difference will be the defining feature of currency trading in 2023.
Of course, there’s a wealth effect from lower house prices in the US and Americans are particularly sensitive to stock market losses but on net Americans are going to come out far ahead. I believe that in the months to come, we will see US consumer spending surprise to the upside over and over again.
It’s an old saying in markets that will prove true again in this cycle: Never underestimate the spending power of the US consumer.
It means there’s a good chance the RBA and BOC have tightened too much and the Fed hasn’t tightened enough.
When a spread between the countries opens up – that’s when we will see a fresh divergence in the US and Canadian/Australian/New Zealand dollars.
In the US, the Fed isn’t really capable of direct-to-consumer pain so the avenue for dampening demand is through businesses and indirectly to consumers via layoffs or job insecurity. But that’s competing with excess savings that still aren’t exhausted.
The main risk I see is that the US consumer stays strong and the global marginal consumer taps out. That could end up being a goldilocks scenario for the US economy where global demand comes down enough to halt US inflation even with America staying strong.
What’s going to be particularly frustrating for AUD, CAD, NZD longs is that this will all happen with global growth staying strong — breaking a multi-decade correlation. China will strengthen this year and the US will surprise — helping commodity markets but not the commodity currencies because domestic markets will be soft and those central banks will be cutting rates.
Where it will get particularly tough is later in the year when the commodity bloc faces struggling economies and falling currencies. That will leave central banks with the devilish choice of cutting rates and further hurting the domestic currency — risking imported inflation. I don’t have a great deal of confidence that they’ll get it right but the right move will be to cut rates anyway.
The good news is that once the housing and rate differential trade washes out in late 2023 or 2024, the commodity currencies will be rescued by a bull market in resources. Wise long term investors will be using depressed AUD, CAD and NZD to buy up resource companies and projects.
How will I know if I’m wrong?
What I’ll be watching most carefully is US consumer spending and then US jobs market. Corporate reports on the US consumer over the holidays are perilous and often contradictory. In addition, the US storms just before/after Christmas could skew the picture this year further.
But I believe that so long as the US jobs market holds up, the US consumer will as well. So the single most-important data point this year may be weekly initial jobless claims . If claims stay sub-300K, the theme remains in play. With that are non-farm payrolls , JOLTS, survey data and layoff announcements. If those crack — and particularly if they crack faster or at the same pace as the rest of the world — then I’ll have miscalculated and will reevaluate.
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