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Although the same issues that fueled volatility in the bond market throughout much of 2022 remain unresolved, we are likely to see increased conviction among investors in the year ahead as the possibilities come into sharper focus. Daleep Singh, Chief Global Economist and Head of Macroeconomic Research at PGIM Fixed Income, shares his thoughts on the fixed income outlook, including insights on inflation and the economic impact we should expect from central bank efforts to reverse its rise via higher interest rates.
U.S. Sets the Pace on Inflation
“In the U.S., we expect inflation to peak at some point in the first half of 2023 as some of the demand-side stimulus that’s been contributing to it goes away,” he said. “The inflation backdrop is more difficult in Europe and elsewhere.”
Domestic energy and food production capabilities position the U.S. to lead near-term progress against inflation at a time when recent election outcomes make more fiscal policy-driven stimulus unlikely. Europe, where the war in Ukraine remains a regional supply chain threat at minimum, seems destined to follow a more gradual and uneven path.
Our expectation is that the Fed is going to begin cutting rates by the middle of next year. That's going to be a big positive for interest rates, particularly short maturity interest rates in the U.S.
Odds Favor Recession, Rate Reversal
Global recession, with inflation retreating toward target trends amid contracting economic conditions, appears to be the most likely outcome at this juncture. Stagflation, where inflation remains elevated against a stagnant economic backdrop, is still a material threat. A soft landing characterized by central bank success in taming inflation without triggering recession is also possible, though not high in probability.
Opportunities should emerge as economic data points improve visibility regarding interest rates. The PGIM Fixed Income team expects the Federal Reserve to begin cutting rates by the middle of 2023, which would be a positive development for interest rates in general and short-maturity rates in particular.
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