Fixed income investors must remain flexible in their thinking and dynamic in their positioning to get the most out of the new year's markets.
2023 Macro watchpoints
US
Inflation was the headline topic for 2022 and its prominence will not diminish as the calendar year turns. However, we expect the mood to shift.
The consensus expectation is that US inflation has peaked and should begin to ease - with this view supported by the 7.7% October CPI number, which showed the smallest 12-month increase since January and a sharp drop from September's 8.2% figure.
As I write this piece, the market is waiting on the final CPI release for the year, due 13 December.
Yellen predicts US inflation will be lower next year
If this easing trend continues, it indicates the effects of monetary tightening measures are coming to fruition.
As such, the US Federal Reserve should not need to raise rates aggressively through 2023. If it is in line or slightly higher, then markets will likely sell off as thoughts return to inflation being stickier and taking longer to come down.
Assuming the number is as expected and inflation starts to cool, remember we are still a long way away from the Fed's 2% target - any change will be gradual.
We expect US interest rates to remain elevated through the majority of 2023.
The effects of rate hikes take nine to 12 months to filter through; given the first of the four 75bps hikes was only announced on 16 June (followed by 27 July, 21 September and 2 November), the full effects of these are yet to hit the underlying economy (expect to see them in spring/summer 2023).
We may well see the effects of those tightening measures ultimately impacting consumer spending, stalling growth and causing a summer recession.
2022 has been all about rates and inflation; next year we expect a greater focus on growth, or a lack thereof.
Europe
Like the US, inflation will remain a core concern for Europe in 2023.
While the November headline number registered its first decrease in 17 months, coming down by 0.6% to 10.0%, Europe is likely already in recession, making the region less economically robust than the US.
The next European Central Bank (EBC) meeting is expected to deliver a final 50-75bps hike, so the interest rate environment versus the US is shorter but remains elevated.
What we expect to see as a result of the weakened economic environment and the rate hikes implemented to date, is that inflation will naturally begin to come down. If it doesn't, you have the potential for stagflation.
The risk of stagflation in Europe is slightly higher than in the US as the economy is weaker, the ECB has less room to raise interest rates yet inflation is roughly at the same level as the US.
UK
The UK has a few nuances on our central scenario for Europe.
The likelihood is that interest rates will not go up as much as the market is currently pricing in because the economic environment is already so stressed - consumers face a twin attack of rising food and energy prices, plus a weaker pound.
We expect the economic environment to tail off rapidly in 2023 with interest rates likely to be cut sometime towards the end of next year.
Investment lessons for 2023
Do not be dogmatic
While it is important to have conviction in your thinking, the short-term, volatile nature of today's markets can mean that hanging onto your investment view for dear life might not end well. You can lose a lot of money chasing two steps behind a choppy market.
Remain responsive
The economic environment has undergone a huge shift over the past 12 months.
Since the first US rate hike in March, we have gone from quantitative easing to tightening with rocketing inflation amidst a rising rate environment.
Even the most confident investor needs to take the daily news flow into account and adjust accordingly.
Active hedging counts
One thing we have learnt this year is that an active hedging policy can be so beneficial.
When you are in an environment of real volatility and real repricing, being able to actively manage that risk given the poor liquidity of the underlying cash market has proven extremely important.
We have been able to build positions that reflect our longer-term views earlier thanks to hedging.
Go unconstrained
In an investment landscape that remains highly uncertain, we believe global unconstrained, benchmark- agnostic strategies offer the best way to capture upside potential amid the turmoil (while managing downside with active hedging).
Unconstrained strategies give investors a broad geographic remit and employ a whole toolbox of instruments in order to access opportunities across the fixed income universe and capitalise on mispriced assets.
Where we see opportunities going into 2023
The final data releases of 2022 are going to set the tone for the new year's markets.
So while we wait on that data, our positioning remains nimble in response to short-term fluctuations.
Investment grade corporates will likely remain a key focus for us and we expect the sub-asset class to do well in H1 2023 as the market adjusts to slower inflation and slow growth.
Once the market prices in a more difficult economic environment then we expect opportunities to emerge at the riskier end of the credit spectrum, primarily in high yield corporates.
Andrew Lake is head of fixed income at Mirabaud Asset Management