Economic outlook brightens slightly but headwinds persist

Although China’s rapid rollback of its zero-COVID policy in December was surprising, its rationale was clear. The country’s economy was under severe strain, with Purchasing Managers’ Index (PMI) falling sharply from mid-year and retail sales and export volume contracting since August.

Figure 1: China PMI (=50, baseline, >50 Expansion, <50 Contraction)

Source: China Federation of Logistics & Purchasing, CBRE Research Q1 2023.

Figure 2: Consumer Spending and Export (% Change From a Year Ago)

Source: China Federation of Logistics & Purchasing, CBRE Research Q1 2023.

While COVID-19 continues to spread across China, infection rates appear to have peaked in coastal cities including Beijing, Guangzhou and Shenzhen. Key mobility indicators in the cities, such as the number of flights and subway ridership, are trending upward.

Figure 3: Number of Flights and Major Cities* Subway Ridership, Seven-Day Moving Average

*Note: Major cities consist of Beijing, Shanghai and Guangzhou.
Source: Macrobond, CBRE Research, Q4 2022.

While this by no means constitutes an economic rebound, early signs of recovery have prompted CBRE to raise its 2023 China GDP forecast from 3.5% to 4.6%, although growth will not be apparent for at least three months.

2023 China GDP forecast from 3.5% to 4.6%, although growth will not be apparent for at least three months. China’s re-opening will have both positive and negative implications for the global economy. On one hand, it reduces the likelihood of a coordinated global recession in which all major economies contract at the same time. On the other hand, it exerts more pressure on commodities markets and complicates the fight against inflation, which has been cooling in recent months.

For most of last year, China’s efforts to contain COVID-19 and resulting suppression of demand had a deflationary effect on the global economy, helping inflation begin to ease off in H2 2022. With the re-opening of economic activity, the Chinese yuan is now strengthening against the U.S. dollar, renewing pressure on western central banks to tame inflation.

Figure 4: U.S. Dollar per Chinese Yuan

Source: Macrobond, CBRE Research Q4 2022.

The anticipated economic slowdown in Europe has been far milder than expected, with declines in both the manufacturing and service sector PMIs for the Euro Area (European Union member states that have adopted the euro as their currency) appearing to bottom out just before the end of 2022. This indicates that while the region continues to skirt recession, economic activity has ceased to contract and is beginning a mild revival, confounding expectations of a sharp decline.

Figure 5: Euro Area PMI

Source: Markit/S&P 500, Macrobond, CBRE Research Q1 2023.

This resurgence is partly a consequence of the steady drop in natural gas prices, which following the relatively warm winter weather and efforts to reduce dependence on supply from Russia fell by around 50% between December 2022 and January 2023. Gas prices on the continent are now back to pre-Ukraine-invasion levels. With Europe on track to end this winter with a record high volume of gas in storage, prices are unlikely to rebound to recent highs, reducing the likelihood of a full-blown energy crisis.

Figure 6: Dutch Title Transfer Facility (TTF) Natural Gas Price

Source: Macrobond, CBRE Research Q1 2023.

Unlike China’s re-opening, lower energy prices in Europe will encourage a reduced rate of inflation, which in December fell for a second consecutive month. CBRE has now upgraded its economic outlook for Europe, with the region expected to narrowly avoid a recession.

Despite a solid labor market and healthy consumption, both U.S. manufacturing and service sector PMI contracted late in 2022, indicating a substantial drop in sentiment. Imports have also begun to fall.

Figure 7: U.S. PMI

Source: Markit/S&P 500, Macrobond, CBRE Research Q1 2023.

Figure 8: U.S. Imports and Exports, $ Billions, Seasonally Adjusted and in Current Dollars

Source: BEA, Macrobond, CBRE Research Q1 2023.

Increasingly the U.S. economy is bifurcated, with growth powered by the fading consumer spending boom while corporations limit their capital investment in the face of rising interest rates.

Financial services activity and residential mortgage applications have fallen significantly in recent months, along with mergers and acquisitions (M&A). Tech firms have already gone through layoffs, with redundancies now also beginning among major investment banks. This is largely the result of the Federal Reserve’s fastest interest rate hikes since the 1980s.

After falling to four-month lows, U.S. bond yields began to rise toward the end of January. The market appears to believe that interest rates will peak at somewhere between 4.75% and 5.0% in Q1 2023, followed by substantial cuts in the second half of the year (Figure 9).

Figure 9: Expected federal funds rate at year-end 2023

What do you think the federal funds rate will be at year-end 2023?

Source: U.S. Investor Intentions Survey, CBRE Research, December 2022.

Figure 10: Expected 10-year Treasury rate at year-end 2023

What do you think the 10-year Treasury rate will be at year-end 2023?

Source: U.S. Investor Intentions Survey, CBRE Research, December 2022.

CBRE’s view is slightly more bearish than the consensus. We believe that the Fed will stay the course despite the risk of dragging the economy into a downturn the year before the 2024 elections. Under this scenario, short-term rates will stay higher for longer.

While there has been some good news on headline inflation (reported through the Consumer Price Index), core inflation (excluding volatile food and energy price data) has yet to fall convincingly, with service sector (the largest component of the economy) inflation continuing to rise. CBRE nevertheless expects the path to sustained low inflation to become clearer in the second half of 2023. The recession in the U.S. will be moderate, with the country’s strong consumer and corporate balance sheets preventing a repeat of the deep recessions of 2001 and 2008.

Despite weaker exports to the U.S. and the downturn in the semiconductor demand (which is impacting Korea and Taiwan in particular), China’s re-opening will provide some relief for Asia Pacific’s export-oriented economies. Other tailwinds include the return of Chinese outbound travelers, which will boost the regional tourism and hotel industries.

Inflationary pressure in Asia Pacific is now declining on the back of weaker global demand, lower energy and food prices and improving supply-chain efficiency. Australia and India are only two major economies where inflation is expected to exceed 4.0% in 2023.

Further interest hikes in major Asia Pacific countries are not anticipated to exceed a total of 100 bps in 2023, with Japan and China being the exceptions in keeping rates low.

CBRE expects Asia Pacific GDP to grow at 3.4% in 2023, maintaining the pace set in 2022. Performance across the region will be polarized, with growth in China set to pick up to 4.6%, but expansion in Australia, Japan and Singapore forecast to fall to sub-2.0%.