Inflation moving away in 2023? Franklin Templeton believe supply chain pressure will ease, central banks focused on policies

Most investors are probably happy to see 2022 in the rearview mirror. Looking ahead to 2023, inflation and the possibility of recession remain the global market’s focal point. Our base case is inflation will further recede as supply chain pressures ease and central banks will remain committed to tighter policy. However, the result of this policy is likely to be a slowing of the economy. This could create opportunities for investors:

• Europe is likely already in a recession and the United States is likely to fall into one—hopefully a mild one. Risk/reward profiles seem to favor fixed income over global equities, particularly for the first half of 2023. Any recession and subsequent recovery may well be rapid and create market volatility. We believe it will be as important as ever to be diversi­fied and actively select investments, particularly when tilting toward risk assets.
• As we discussed in our most recent Macro Perspectives,¹ expensive equity prices and the potential for a peak in interest rates have been driving a preference toward fixed income. We expect investors to search for quality and perhaps increase duration in 2023, with some ideas to consider: Extending duration may provide compelling income opportunities, and US Treasuries could be the core for building duration.
• Investment-grade (IG) corporates look like an attractive place to us for investors seeking relatively safe income.
• High-yield (HY) credit looks attractive for investors with a multi-year time horizon, in our view, as current yields and active selection provide a cushion for potentially near-term higher defaults in the sector.
• The key takeaway: “Don’t fight the Fed.” Bonds will likely rally as the US Federal Reserve (Fed) achieves its goals, whether the US economy’s landing is soft or hard. Equities are less likely to perform as well—unless the landing is soft. Otherwise, falling profits will offset falling bond yields and equities are unlikely to advance. That outcome is also a recipe for elevated equity volatility.
• Some investments can act as a hedge against inflation and potential downgrades in earn­ings. The impact of inflation on listed infrastructure in 2023 should be muted, particularly for regulated assets, which often have inflation adjustment clauses. Infrastructure earnings look better protected in general than global equity earnings, in our view.
• Historically, US commercial real estate investment has performed favorably in periods of rising interest rates and inflation. Current macro risks and market dislocations may create attractive buying opportunities over the next 12–18 months in some sectors of commercial real estate.

For more detailed insights and outlooks from our investment teams, please read our full Global Investment Outlook. On behalf of Franklin Templeton Institute, we look forward to a more prosperous new year!