EXECUTIVE SUMMARY

• As Russian gas supply is coming to a halt, the fight against inflation is raging and political uncertainties coalesce, our previous adverse scenario has become reality. The trifecta of lower growth, higher inflation and higher rates will hit even harder. We expect global growth to slip into negative territory in Q4 (-0.1% q/q), followed by a slow recovery at +1.5% in 2023. Consumer sentiment has already plunged to record lows and business confidence continues to deteriorate rapidly, which will hold back consumption and investment.
• Eurozone growth is likely to plunge to -0.8% in 2023 due to soaring energy prices and negative confidence effects. Increased fiscal support to the tune of 2.5% of GDP on average and limited monetary easing after mid-2023 will help make the recession shorter and shallower, and limit the risks of social unrest. But it will not fully offset the shock on real disposable incomes and corporate margins.
• The US will register a -0.7% fall in GDP, mainly due to rapidly tightening monetary and financial conditions, which will significantly cool the housing market, coupled with a negative external environment and low fiscal support after the mid-term elections.
• Inflation will remain high until Q1 2023 after energy prices have peaked, with food and services adding upside pressure. We expect global inflation to average 5.3% in 2023 (after close to 8% in 2022). Eurozone inflation should peak at 10% in Q4 2022 and then average 5.6% in 2023. In the US, inflation is likely to have peaked already but should remain above 4% until Q1 2023, falling below 2% only after Q3 2023 (averaging 2.9% in 2023).
• Central banks’ determination to fight inflation could lead short-term sovereign rates to go above neutral terminal rates in both the US and the Eurozone (to 4% and 2.25%, respectively). Both the Fed and the ECB will remain hawkish compared to other recession episodes, with limited rate cuts after mid-2023. We expect persistent yield-curve flattening until year-end, with recession concerns keeping long-term rates anchored at 3.25% in the US and 1.6% for the 10Y German Bund.
• Several emerging market (EM) countries are at risk of balance-of-payments crises (Argentina, Chile, Colombia, Egypt, Hungary, Kenya, Pakistan, Poland, Romania, and Turkey). While EM sovereign risk is already reaching dangerous levels, there is room for a further increase in yields and spreads. Even if the global economy avoids a deeper recession, we do not expect conditions in EMs to improve until late next year.
• The outlook significantly depends on the impact of financial tightening across major economies and the effectiveness of fiscal support. We see further downside risk to equity valuations before markets recover next year, with single-digit returns.
• Corporate risk has risen again, but higher fiscal support should prevent a large wave of business insolvencies and an acceleration in severity rates. Nonetheless, for the Eurozone overall, we expect insolvencies to increase by more than +40%. Corporate credit spreads should experience a contained widening but some spread compression next year. Deeply negative real rates facilitate higher deficit spending to cushion the impact of the cost-of-living crisis on consumers and firms. However, they also leave countries with higher debt levels at a time when interest rates are rising, which increases the pressure for a potentially painful fiscal adjustment at the end of next year.
• Key political events will bring further volatility and higher geopolitical tensions – notably the increased US-China rivalry and Europe’s response to the energy crisis – will provide additional tailwind fuel to current decoupling tendencies.