As the new year kicks into gear, T. Rowe Price has outlined five key themes that the investment management organisation expects will influence financial markets in 2023.

Tim Murray, capital markets strategist, multi-asset division at T. Rowe Price, said in a recent note that, after beginning 2022 at elevated levels, equity valuations quickly adjusted downward when investors realised that significant interest rate hikes were looming.

“While equity markets sold off meaningfully during 2022, earnings expectations fell only modestly. This, unfortunately, means that a decline in earnings expectations in 2023 due to a global recession could worsen the sell‑off in stocks,” he suggested.

Along with valuations, Mr Murray highlighted the influence of the US Federal Reserve’s unwavering commitment to fight inflation as an influential theme for the coming year.

He said that market expectations for the federal funds rate were consistently too low last year, and noted that how high rates go and how long they remain at elevated levels are still unclear.

“What is clear is that they are determined to avoid a replay of the 1970s and will do whatever it takes to get inflation back to healthy levels, even if their actions push the U.S. economy into recession,” said Mr Murray.

“In 2023, the Fed’s primary focus will be on lowering wage inflation, and we should not expect a shift in policy unless the labour market also weakens considerably.”

One major lesson from 2022 that will carry over into 2023, according to Mr Murray, is that stocks and bonds can sell off simultaneously.

While bonds typically provide protection from falling equities, Mr Murray said this is not always the case, particularly when the Fed has begun a new hiking cycle as was seen in 2022.

“Further, 2022 was somewhat of an outlier because the Fed usually tightens when growth is accelerating — which was not the case in 2022 — and interest rate hikes are typically more gradual,” he explained.

“Fortunately, stock/bond correlations should likely fall in 2023, as the Fed appears close to the end of its hiking cycle.”

A silver lining to the falls seen in bond markets and another influential theme for the year ahead, Mr Murray said, is that bonds now have healthy yields once again.

“This means that investors no longer have to take significant credit risk to get a healthy yield from their bond portfolio. In addition, investors can also enjoy a potentially larger income buffer to help offset any further increases in interest rates and/or credit spreads,” he said.

Rounding out the list of themes that will influence markets this year, Mr Murray pointed to policy changes taking place in China as a major development.

“Chinese government has indicated that economic growth remains important, it intends to reinvigorate socially oriented goals. Investors should be prepared for changes going forward,” he concluded.

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