In an ever-changing global economy, investors need to stay on top of news and forecasts that could affect their portfolios. Black swan events, however, are those events that have a very low probability of occurring and are unpredictable but nevertheless happen and have a significant impact, such as 9/11 and the new pneumonia epidemic. This article will closely examine the predicted Black Swan event of 2023 by Morgan Stanley’s Matthew Horbach and his team, suggesting strategies to prepare for the possible changes in the market.
1. Despite Economic Recession, the Fed Reserve Will Not Cut Interest Rates
The U.S. economy slid into recession in 2023, but the Fed won’t cut interest rates until 2024. They’re worried about inflation being “sticky” and don’t have time to think about the slowdown of economic growth and weakness in the labor market. They want to wait for evidence proving that inflation is still falling. Morgan’s report suggests that the 10-year U.S. treasury bond will not decline much in the recession coming in 2023, and the 10-year yield will continue to be inverted to the 2-year yield on the U.S. bond.”
2. U.S. Bonds are Facing Liquidity Challenges that May Cause the Fed to Suspend Quantitative Tightening (QT)
Most investors expect the Fed’s second QT to end due to a shortage of reserves or a cut in interest rates, but the issue of U.S. bond liquidity is likely to be another obstacle to QT. The New York Fed survey in November showed that the market expects the Fed to stop tapering in Q3 2024, which is broadly consistent with our expectation that “QT will end by mid-2024 as the Fed begins to see reserve shortfalls.”
According to Morgan, higher volatility and reduced ability of the primary market to absorb U.S. debt will be the two main factors in the drying up of U.S. bond liquidity. These factors will continue into next year, creating the possibility that the Fed will have to intervene to suspend or end its program of QT.
3. Europe Central Bank (ECB) Starts to Cut Interest Rates in the Second Half of 2023
Morgan Stanley believes that the ECB’s aggressive rate hikes have caused mortgage rates to rise, and housing prices in Europe will start falling from the second half of 2022. Considering that the ECB is still continuing to tighten monetary policy, European housing prices may soften further, and the ECB may start cutting interest rates in the second half of 2023.
The report states, “In our view, global housing prices have fallen by more than 15%. If the ECB continues to tighten in 2023 Q1, we predict housing prices will fall faster, and the ECB rate will peak at 3.25% in May. It could imply a total rate drop of 150 bps in September, October, and December. By the end of 2023, the 10-year bond rate would be below 1%.”
4. Japan’s black Swan – the Bank of Japan (BOJ) Maintain Its Policy
Currently, both Japanese and overseas investors generally believe that in 2023, with the retirement of Haruhiko Kuroda, the BOJ will have some policy adjustments under the leadership of the new governor. Still, there is also a possibility that the BOJ will not be able to move toward normalization.
The report points out that the market has priced mainly in Japan’s policy shift, and the main reasons behind this expectation include:
- Growing evidence that inflation has begun to rise;
- Further deterioration in bond market liquidity.
Yet, the BOJ may fail to proceed toward normalization in the face of a weakening global economy, slowing inflation, and the potential of other central banks relaxing.
Morgan believes investors will be disappointed if this occurs, favoring a flattening of the Japanese 10-year bond yield curve. At the same time, the yen will continue to weaken and return to the rate that market has become accustomed to under yield curve control if global recession fears intensify in 2023.
5. U.K. Black Swan – Pounds Rallies
There has been a near-unanimous pessimistic outlook on British Pounds in recent months. At the same time, the market is not optimistic about the UK’s economic development in 2023. However, the report points out that three potential factors could drive the pound higher:
- A sharp drop in energy prices would be a key driver
- The return of labor supply
- Boosting consumption by using excess savings or driving up payroll growth.
6. Canada’s Black Swan – Stronger Canadian dollar
This year, Canadian housing prices and the Canadian dollar’s weakness have been hot topics. Recently, the Canadian dollar has underperformed, partly due to concerns about the housing market. According to all indicators, the housing market has peaked and is starting to fall. If the Bank of Canada tightens mortgage standards, the number of people entering Canada will increase. In this scenario, the housing market could be stabilized while the Canadian dollar is under pressure.
7. The US Federal Reserve Accepts Inflation above 2%.
Morgan Stanley reported that the approaching review of the US Federal Reserve’s 2025 monetary policy framework might lead the US Federal Reserve to consider changing its inflation target in 2023. However, the likelihood of this is low.
The new framework allows the Fed to accept deviations from 2% inflation. With stubborn inflation from 2021 to 2022, the market’s first reaction is to price in a higher inflation risk premium and slightly raise inflation expectations. A 2% inflation target change means the long-term break-even point, and the 10-year US bond yield will rise in 2023.
8. UK Bonds are Being Sold Again
Morgan believes investors are not prepared for a poor performance of UK Treasuries in 2023. The market believes that the UK Debt Management Office will work with the Treasury to issue more Treasury bills and short-term bonds, but if this does not happen, there will be another Treasuries sell-off in September 2022.
How Do Investors Get Prepared for Black Swan Events In 2023?
Diversify your portfolio
The key for investors is maintaining a diversified portfolio to weather market volatility regardless of the cause. While there’s no way to predict or avoid black swan events, having a diversified portfolio is always a defense strategy against the impact of these events. Regularly review your portfolio to see if it is achieving its diversification objectives and benefits and to ensure that you make the right decisions promptly when the market changes.
Consider Buying Safe Heaven Assets
If you haven’t invested in recognized safe haven assets, consider adding some, such as government bonds, gold, and other precious metals. These assets tend to hold their value or even increase in value when markets are experiencing turmoil.
In addition to bonds and gold, Goldman Sachs sees the yen as an ideal hedge against the risk of a recession in the U.S. JP Morgan also believes that hedging activity could significantly support the yen because the yen’s valuation remains reasonable.
Long-term Investment Horizon
Over the long run, the markets tend to move back to normal. With or without black swan events, the markets can spike up or down for many reasons, so remember not to buy or sell immediately when some major event occurs. Discipline and sticking to your long-term plan sometimes are essential mindset to success.
While black swan events are impossible to predict, investors can take measures to protect their portfolios. The first thing you can do is to keep up with global news and events, as they can provide important clues about potential black swan events. Diversification is critical to mitigating these events’ effects. As an intelligent investor, you should always have a long-term investment horizon to weather short-term market volatility.
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