Macroeconomic update by François DUHEN, Chief Economist and Strategist CIC Market Solutions - 1^st semester 2023

The first half of 2023 was marked by a return of fears about growth prospects, concomitant with continued monetary tightening by central banks. The persistence of inflation, particularly core inflation, which led the European Central Bank (ECB), the Fed and the Bank of England (BoE) to continue their monetary tightening, was compounded by an episode of financial turbulence related to the default of US regional banks and Credit Suisse. Risk aversion was also fuelled by negotiations over the suspension of the US federal debt ceiling and the prospect of default should the US Treasury fail to meet its commitments in June. Better than expected, economic activity nevertheless showed signs of slowing, particularly in the euro zone, which entered a technical recession in Q1. In China, after a first quarter marked by a substantial rebound in economic growth following the post-pandemic reopening, the recovery in activity was disappointing, particularly in industry, weighing on commodity prices and fuelling expectations of greater fiscal and monetary support from the authorities.

In the euro zone, inflationary pressures remained persistent, with core inflation (excluding energy and food) slowing to +5.4% y-o-y in June (vs. +5.5% for headline inflation), prompting the ECB to raise its key rates four times since the start of the year, by 150 basis points (bp) to 3.5% for the deposit rate. It has also accelerated the reduction in the size of its balance sheet, by not reinvesting securities acquired under the historic asset purchase programme (APP) and repaying banks' long-term lending operations (TLTRO). These measures contributed to a tightening of financial conditions and a slowdown in lending. While financial investors at one stage anticipated a slightly less restrictive monetary policy due to fears of a systemic banking crisis, following the difficulties in the US and Switzerland (the takeover of Credit Suisse by UBS), the ECB affirmed its confidence in the resilience of the euro zone banking system, and reiterated its ability to deploy emergency measures if necessary to ensure financial stability. Faced with a labour market still under pressure and conducive to second-round effects via wage pressures, the institution's members reiterated the need for further monetary tightening, which led to a clear appreciation in European 2-year sovereign yields (by almost 50bp over the half-year), while their 10-year peers fell back slightly from their levels at the start of the year. At the same time, although better than expected, economic growth showed signs of weakening as the euro zone entered a technical recession (two consecutive quarters of contraction, at -0.1% sequentially in Q1-2023 and Q4-2022), particularly in industry, as in Germany. Moreover, thanks to reduced risk aversion and resilient economic activity in Italy, the Italian-German 10-year sovereign spread narrowed significantly at the end of the half-year (-50bp).

In France, growth moved back into positive territory on a sequential basis in Q1-2023 (+0.2% vs zero growth in Q4-2022) on the back of a rebound in foreign trade (strong rise in transport exports and reduction in energy imports), while domestic components continued to suffer. Business and household confidence indices deteriorated in Q2-2023, including in services, which are now in contraction territory. Rating agency Fitch downgraded France's sovereign rating from AA to AA- (with the outlook raised from negative to stable) due to reservations about the public finances trajectory and the social context that followed promulgation of the pension reform, which it believes is complicating the government's reform prospects. Note, however, that S&P subsequently maintained its rating unchanged at AA (negative outlook).

In the UK, the persistence of inflation (year-on-year: +8.7% in May for headline inflation and +7.1% for underlying inflation) and tensions on the labour market (wages), well beyond its projections, led the BoE to accelerate its key rate hike (+150bp to 5% in four meetings, with a 50bp lift again at the last meeting in June). The prospect of further monetary tightening contributed to a sharp rise in sovereign yields (10-year: +70bp), particularly for short maturities, even exceeding the peaks in autumn 2022 (2-year: +160bp), and the pound (+3.2% against the euro). Business activity has remained resilient so far, as evidenced by growth in Q1-2023 (+0.1% sequentially) and the robustness of the PMI activity indicators.

In the United States, regional bank failures and then fears of a US sovereign default marred the first half of the year and contributed to substantial volatility movements. The failure of regional banks in March, notably Silicon Valley Bank, compelled the Fed and regulators to deploy exceptional measures in order to guarantee deposits and access to liquidity for US credit institutions (almost $300bn of liquidity). Since then, with the exception of the First Republic takeover, the signs of banking stress have eased (stabilisation of deposits, stability of the interbank market). Fears of a sovereign default, which according to the US Treasury could have occurred in early June, then took over when the federal debt ceiling was hit in mid-January. The White House and the Republican opposition in Congress reached an agreement at end-May on a bill suspending the ceiling until 2025, i.e. after the presidential elections in November 2024, in return for limited government spending for the 2024 and 2025 fiscal years. Despite these incidents, which contributed to the volatility of sovereign yields, the Fed devoted its efforts to fighting persistent core inflation (the Fed's preferred PCE index stood at +4.6% y-o-y in May) and the still inadequate normalisation of the labour market, by raising its key rates by 75bp in four meetings (taking the target range to 5%-5.25%). This contributed to the sharp rebound in short-term sovereign yields (2-year: +50bp). Although the Fed decided to mark a pause in June by leaving its key rates unchanged, it nevertheless hinted at possible future rate hikes, an analysis based on demand that is still resilient. Economic growth remained dynamic in the first quarter (+0.5% sequentially) and services activity continued to expand despite slowing down. These trends, combined with the wave of enthusiasm for artificial intelligence, have enabled US equity indices to outperform their European peers considerably (+15% for the S&P 500 vs. +4% for the Stoxx Europe 600).

In China, after a substantial rebound in economic growth in the first quarter (+2.2% sequentially) following the post-Covid reopening of the economy, mainly in services, momentum showed signs of slowing, particularly in industry, which was weakened by subdued domestic and foreign demand. Against this backdrop, and with inflation very low, the People's Bank of China stepped up its monetary support by cutting its main short- and medium-term interest rates in order to support investment and consumption. This has nevertheless accentuated the depreciation of the yuan (-4.8% against the dollar). In addition, geopolitical tensions with the United States increased, notably over the war in Ukraine, a year after the start of the Russian invasion, and suspicions of espionage. In Brazil, Lula's government is trying to reduce the public deficit, and it has benefited from renewed investor confidence (reflected in the appreciation of the real and the rise in the Bovespa share index). Although inflation continued to slow substantially, the Brazilian central bank kept its key rates unchanged throughout the first half of the year.

In commodities, the weakness of Chinese industry weighed on oil prices (down 13% at $75/b), despite the decisions of the OPEC+ countries to cut their production by 2.66 million barrels a day (1.16 million b/d from May, plus the extension of the 500,000b/d cut in Russian production until the end of the year and Saudi Arabia's decision to cut production by 1 million b/d from July) to support prices. Industrial metal prices, which had risen for a time at the start of the half-year, were also affected by weak demand in China. Lastly, European gas prices fell by 35% to €37/MWh, due to favourable weather conditions, efforts to reduce demand and sourcing diversification.