Macroeconomic update by François DUHEN, Chief Economist and Strategist CIC Market Solutions - July / August 2023

July and August were marked by a period of volatility in sovereign yields, particularly long-term rates, exacerbated by thin summer trading volumes. Although central banks continued to tighten monetary policy, resilient economic growth, particularly in the US, heightened fears that they would maintain a restrictive monetary policy for longer in order to support the ongoing disinflation process. The shift in monetary policy by the Bank of Japan (BoJ) since its meeting at the end of July, and factoring in of an acceleration in US Treasury debt issuance, combined with Fitch’s one-notch downgrade of the US’s sovereign rating, are other factors that may have been behind the rise in long-term rates and, consequent difficulties for the equity market. In China, fears over the property crisis and the economic slowdown led the authorities to step up monetary and budgetary support measures and regulatory announcements over the summer, following the Politburo meeting.

In the eurozone, the European Central Bank (ECB) raised its key rates by 25 basis points (bp) in July (to 3.75%-4.25%). The press release and the answers given by its President, Christine Lagarde, at the press conference, which was slightly more cautious in tone, demonstrated the ECB's determination not to commit to a pause or a rate hike at the next meeting in September. This data-dependent approach was reiterated by various members of the ECB, particularly at the Fed's Jackson Hole symposium, where they referred to the worsening economic outlook. Inflation, particularly core inflation (excluding energy and food), continued to slow (to +5.3% year-on-year in August), while economic activity showed signs of a more marked slowdown after a better-than-expected second quarter (+0.3% quarter-on-quarter in the first estimate). The PMI activity indicator fell back into contraction territory in August, including in services, which had previously been expanding. Against this backdrop, long-term European sovereign yields rose sharply in August (German 10-year: +15bp over two months), while their short-term peers fell more (German 2-year: -20bp over two months). The euro depreciated against the dollar, sterling and Swiss franc. We should also mention that the opposition Popular Party won the early general elections in Spain, albeit without managing to secure an absolute majority against the Socialist Party of outgoing Prime Minister Pedro Sanchez.

In France, growth accelerated sequentially in Q1 (to +0.5% vs. +0% revised down in Q1), but this is mainly due to the performance of foreign trade, while consumption, which is contracting, and investment reflect the weakness of demand. Inflation accelerated in August y-o-y (to +4.8% vs. +4.3% in July) due to the rebound in energy and food prices, while the prices of goods and services slowed.

In the United Kingdom, the Bank of England (BoE) raised its key rates by 25bp to 5.25% in a decision that was less consensual than usual. Although the UK inflation rate continued to slow in July (to +6.8% y-o-y), this was largely due to the fall in energy prices. Attention remains focused on the core component, which is no longer managing to slow y-o-y, stabilising at +6.9%. This persistence of underlying prices, particularly in services, is still due to dynamic wage increases (+7.9% y-o-y in July, excluding bonuses), despite the rise in the unemployment rate.

In the United States, the Fed raised its key rates by 25bp, taking the target range to 5.25%-5.5%. With regard to the central bank's future decisions, the Fed chairman remained open to various possibilities (whether to pause or raise rates) and stated that he would maintain a data-dependent approach, a stance he reiterated during his speech at the Jackson Hole symposium. Core inflation continued to slow in July (+4.7% y-o-y vs. +4.9% in June for CPI data published in advance), while headline inflation accelerated slightly (+3.2% vs. +3% in June) due to energy prices. Nevertheless, the labour market sent out mixed signals in July. While job creation has become increasingly less buoyant (+187k with a downward revision of 49k jobs over the last two months), wages remain high (+4.4% annual variation) in a context where the unemployment rate remains close to its all-time lows (3.5% vs. 3.6% in June). Long-term sovereign yields rates thus experienced a significant upward movement in volatility in August, fuelling a steepening of the yield curve, also due to: 1) the BoJ's monetary adjustment (easing control of its yield curve control); 2) a programme of high bond issuance planned by the US Treasury in August to be ramped up over the coming quarters; and 3) the resilience of activity. The latter was illustrated by the first estimate of Q2 GDP (+2.4% q-o-q annualised; +2.1% 2nd estimate) and the ISM activity indices for July, which are resilient, particularly in services. Finally, Fitch Ratings downgraded the US sovereign rating from "AAA" to "AA+", citing growing concerns about fiscal management, both in terms of public finances and politically, given the polarisation of Congress. These various factors also weighed on the performance of equity markets, with risk aversion rebounding significantly, even though US indices fared slightly better than their European peers, which benefitted less from the renewed enthusiasm for artificial intelligence following Nvidia's excellent results (S&P 500: stable since the beginning of July and -3% since the beginning of August, vs the Stoxx Europe 600 down -2% and -4% since the same dates, respectively).

In China, the authorities stepped up their announcements and support measures over the summer, targeting the real estate sector in particular, in response to falling activity and exacerbated difficulties in the sector illustrated by the setbacks of property developer Country Garden. In terms of monetary policy, against a deflationary backdrop (-0.3% in August year on year), the central banks has, for example, reduced several of its interest rates, and has instructed state banks to reduce interest rates on outstanding property loans. However, these announcements failed to reassure investors, as evidenced by the marked underperformance of Chinese equity indices (-9% since the end of July). The yuan's depreciation in August, following the Politburo meeting, also reflects disappointment at the scale of the measures, which were deemed insufficient to revive activity (whose growth in Q2 was disappointing) and confidence.

With respect to emerging market countries, in Brazil, the central bank has cut its key rate by 50bp to 13.25% (versus -25bp expected), while Lula’s government has unveiled a huge stimulus plan of €350bn, targeting infrastructure, most of which will be deployed by 2026. In India, the central bank has maintained its key rate at 6.5%, in spite of the sharp acceleration of inflation in July owing to the increase in agricultural commodities prices.

In terms of commodities, oil prices accelerated sharply (from 75/barrel at the end of June to close to 90/barrel at the end of August) due to a combination of favourable factors on both the supply side (decline in Russian sea exports, Saudi Arabia's voluntary production cut taking effect and being extended to the end of the year) and the demand side (resilient US demand, buoyant activity in the airline sector and robust Chinese oil imports). In addition, Russia's decision to terminate the Black Sea Grain Initiative in July led to volatility in wheat prices, while some agricultural commodities, such as vegetable oils, saw their prices rise.