Last year began with expectations that the global economy would continue its post-COVID recovery trend. Nobody imagined that this would be plane sailing, with inflation and supply-chain disruption the primary concerns, but nor was the agitated, stop-start economic reality of 2022 expected either.

While in hindsight the war in Ukraine had a grim inevitability about it, its timing and impact took markets by surprise. Energy and commodity prices rose sharply as concerns over supply chain disruption grew ever more acute. These concerns, by and large, did not manifest themselves in 2022, and despite various sanctions and posturing, raw material flows continued almost unabated. As the months rolled on, supply-side fears gave way to demand-side anxieties as the Chinese economy faltered and global recession loomed.

In China, the ‘zero-COVID’ policy, characterised by aggressive testing, travel bans, and strict lockdowns took its toll on domestic consumption and contributed to (further) deterioration of the Chinese property market. While export markets offered some relief, GDP growth for the year was most likely in the 3.0-3.5% range – its lowest level since 1976 if 2020 (the pandemic year) is excluded. Project Blue believes that the recent decision to relax the ‘zero-COVID’ policy is principally motivated by the urgent need to revive China’s domestic consumption and stabilise its property market in the context of a deteriorating global economy.

Despite the precarious economic situation, the 20th National Congress of the Chinese Communist Party went ahead as planned, confirming Xi Jinping for an unprecedented third term in office. Party Congress rhetoric signalled a continuation of the economic and commodity-related policies set out in China’s 14th Five-Year Plan (2021-25), namely a focus on supply security, energy transition, greater efficiency, and technological innovation. It appears that Beijing will not revert to large stimulus measures such as infrastructure spending to boost activity which will have a knock-on effect for steel and ferroalloys markets in particular.

In the USA, the economy showed its resilience in 2022 despite quantitative tightening. The US Federal Reserve hiked interest rates seven times in 2022 from 0-0.5% to 4.25-4.5%, putting rates at their highest level in fifteen years. US economic resilience can in part be explained by the excess savings built up over the pandemic, much of which is linked to stimulus. This cash pile helped put a floor under consumers facing higher prices and borrowing costs – softening and postponing the negative impact of tightening monetary policy and delaying economic slowdown.

On the policy front, the passing of the Inflation Reduction Act (IRA) in 2022 was of monumental significance. The IRA is the first comprehensive climate law in American history and while focussed mostly on the domestic economy, it has huge implications for the world and will influence the geopolitics of climate change, energy transition and as a result commodity markets. Unequivocally, US policymakers are now focused on building resilient supply chains with a focus on semiconductors, batteries, and critical materials.

Europe has been particularly hit by the war in Ukraine and by the surge in gas prices which rose from US$3.70/MMBtu at the end of 2021 to US$9.70/MMBtu in August 2022, before dropping to the US$5.00/MMBtu level in late December. With the EU traditionally relying on Russian gas for 40-45% of its requirements, securing alternatives at competitive prices remains a key issue for Europe. All in all, the energy crisis was not as bad as initially expected in 2022 – with a mild winter meaning inventories were kept at comfortable levels.

However, energy crisis eroded households' purchasing power and weighed on industrial production. Meanwhile, higher energy costs and a weak Euro caused inflation to rise steadily, reaching 10.6% year-on-year in October, up from 5.1% year-on-year in January. Although more cautious in its rhetoric than the Fed, the European Central Bank (ECB) increased rates four times in 2022 from 0% to 2.5%.

We expect modest global growth in 2023, with the upside skewed to the second half of the year. We believe that China will outperform expectations, that any recession in the USA will be relatively mild, and that Europe will lag behind. While interest rates should peak in H1, they may stay higher for longer, depending on the nature of Chinese economic recovery. Higher and stickier inflation – with associated consequences – represents a key risk for 2023, with geopolitics and possible further COVID outbreaks/lockdowns as wild cards.

Our outlook for China is that the economy may surprise on the upside, although the economic improvement may not materialise until Q2, after Chinese New Year. This expectation assumes a steady, if bumpy, reopening from COVID lockdowns and a reasonable taming of the virus’ impacts in 2023. Given the prevailing weak global macroeconomic environment, stimulating domestic consumption is of paramount importance for China if it wants to avoid another bad year. The policy reversal about ‘zero-COVID’ is, in our view, a clear signal that the Chinese government subscribes to this belief. Our base case assumes Chinese GDP growth of 4.5-5.0% in 2023. Importantly, a weak RMB could benefit Chinese exports, should the world economy recover in H2 2023.

The jury is still out on whether the USA will enter recession in 2023 or whether the Federal Reserve will manage to engineer a ‘soft landing’. Project Blue believes that a recession is most likely, although the magnitude and duration remain uncertain. The Fed has been slowing the pace of its rate increases and our expectation is that interest rates will peak at 5.0-5.5%. However, there is potential for a stronger Chinese economy to keep global inflation at a higher level, preventing the Fed from cutting rates in 2023 as the market expects. This could translate into a prolonged economic downturn.

Our outlook for Europe remains one of weakness for 2023. The continent faces higher energy costs over the medium term, given its commitment to diversify away from Russian energy imports. Mild temperatures could keep prices under control this winter, but gas restocking is almost certain to be an issue in 2023. The war in Ukraine remains a wild card and an end of the war in 2023 would provide an enormous boost to the continent – socially, politically, and economically.

12

12

11

11

9

9

9

15

15