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Six Grey Swans That Could Unsettle Markets in 2023

Global Chief Investment Officer

At State Street Global Advisors, our Global Market Outlook encapsulates our views on investment and economic prospects for 2023. However, we recognize that the future is always uncertain and believe that consideration should also be given to alternative scenarios that have a reasonable, if low, probability of occurring. We call these scenarios Grey Swans.

Unexpected events in the last few years, from the Covid-19 pandemic to war in Ukraine to double-digit inflation, illustrate why thinking about Grey Swans can help inform the risk-aware approaches we apply across our portfolios. We have identified a group of Grey Swans to watch in 2023. To learn more about our thinking underlying each of these scenarios, please download the complete article “Six Grey Swans That Could Unsettle Markets in 2023” by Lori Heinel and Gaurav Mallik.

1. Outright Deflationary Bust

In what is probably our darkest Grey Swan, we identify a scenario in which major central banks reassert a hawkish approach to monetary policy. Multiple rate hikes get delivered on top of already high rate levels, with a Bank of Japan exit from its yield curve control policy then contributing to global bond yields jolting higher. At the same time, China’s reopening from Covid restrictions sees the country’s leadership adopt an aggressive price competitive approach to bolstering growth. Unemployment finally rises in earnest, likely stoking retrenchment in consumer and business spending. Amid weakening global demand and improved supply, oil prices tumble to send a deflationary impulse through the economy.

The impact would be considerable. For investors, portfolio positions in Treasuries would be rewarded while equities, credit, commodity, and real estate markets suffer losses. Against the backdrop of central banks reverting to quantitative easing policies to support economic activity, opportunities should emerge for investors to pick up long duration assets at relatively more attractive entry points.

Figure 1: Deflationary Bust: Impact on Investment Assets

Grey Swans Fig 1

2. Scarce Liquidity Creates Rupture

Fear of a liquidity event keeps many investors awake at night. Even the US Treasury market is not immune to such concerns, despite its renowned depth. In this Grey Swan, diminished market liquidity would amplify the risk of a rupture under circumstances where a more hawkish Federal Reserve exacerbates heightened market volatility in pursuit of quashing inflation.

A rupture in the US Treasury market, a linchpin for all other interest rates, would not only severely disrupt mortgage markets, corporate funding, vast numbers of derivatives contracts, but would also undermine other major asset classes from stocks to commodities, real estate and beyond. A jump in bond-equity correlations might see investors scrambling for second-line hedges such as gold, broad commodities, or selected alternatives.

Figure 2: Deterioration in Treasury Market Liquidity

Grey Swans Fig 2

3. Housing Market: Abrupt and Sharp Correction

In this Grey Swan, the housing market correction takes a more ominous turn, with high prices adjusting sharply lower to help clear a market suffering from record low affordability and freefalling demand. An increase in unemployment could set the scene for rising defaults, leading to foreclosures that adds more supply to the market; home prices decline by 15-20%. However, because the housing supply had lagged household formation for years, buyers should soon emerge to put a floor under prices.

For investors, this correction would differ from the global financial crisis; banks are much better capitalized to endure the impact. Housing-related sectors would take a hit, from construction to materials sectors, with a negative wealth effect dampening spending as homeowners turn cautious; consumer staples should thus fare better than consumer discretionary stocks.

4. Euro Strikes a Record Low

Could something as simple as an extended cold winter be the trigger for the euro slumping to a record low? A depletion of natural gas reserves and an eye on the 2023/24 winter would likely drive energy prices (and overall inflation) higher, raising fears of increased European Central Bank policy rates. A retreat to more nationalistic positions on energy, immigration and fiscal policies could create political divisions within the European Union.

A breakup of the eurozone seems highly unlikely in this Grey Swan scenario, but the fear of a single country exit in an environment of recession, rising political tensions, and high debt levels, could drag the euro toward its previous record low of $0.84. The combination of slower growth and potentially higher ECB rates then results in renewed divergence between core and peripheral debt yields as investors adopt a safety first approach. Allocations away from euro area equities could see UK shares preferred as investors adjust Europe exposures.

5. Major Oil Price Spike

While the war in Ukraine, OPEC+ cuts in production, and a pandemic reopening surge in demand took crude oil prices above the $100 per barrel mark for half of 2022, prices ended the year closer to their starting point.1 In a world where sanctions on Russia already restrict supply and the threat of tensions bubbling over in other oil-producing regions is ever present, a catalyst that could make sharply higher oil prices more tangible in 2023 is a larger-than-anticipated economic response to China’s scrapping of Covid-related policies. This could stoke oil demand from Chinese industry and also have a positive impact on other emerging markets that have intertwined economic relationships with the world’s second-largest economy.

Another spike in energy prices would deliver another stagflationary impulse, particularly in Europe. For investors, the impact might warrant continued use of commodities as a portfolio hedge, as well as investment in oil-related stocks, from Big Oil to energy sub-sectors.

Figure 3: World Liquid Fuels Production and Consumption Balance

Grey Swans Fig 3

6. Semiconductor Drivers Bounce Back

In what was a truly volatile 2022 for US equities, the broad technology sector had a difficult year. Performance dispersion within the sector was high, with leadership particularly narrow. The semiconductor industry proved one of the worst performers — down over 30% for the year as it posted its worst performance relative to the S&P 500 Index in over a decade.2 But what if the drivers for the market’s pessimistic assessment shifted? The semiconductor sector could swivel from market laggard to market leader.

The trigger for a reversal in fortunes lies in a significant US policy pivot that further tempers dollar strength and delivers a positive growth surprise. Given that the semiconductor industry garners more than 80% of its revenue from overseas markets, this would be impactful. An economic growth surprise on more dovish Fed actions could drive increased productivity/capital expenditures and, more importantly, revive sentiment for the highly cyclical semiconductor industry.


Bio Image of Simona M Mocuta

Simona M Mocuta

Chief Economist

Bio Image of Matthew Nest

Matthew Nest, CFA

Global Head of Active Fixed Income

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Desmond Lawrence

Senior Investment Strategist

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Aaron R Hurd, FRM

Senior Portfolio Manager

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Elliot Hentov, Ph.D.

Head of Macro Policy Research

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Matthew J Bartolini, CFA, CAIA

Head of SPDR Americas Research

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