Macroeconomic update by François Duhen - February 2023

Central banks’ more confident communication on inflation and the scale of the monetary tightening that will be necessary following the monetary policy meetings in February was quickly eclipsed by the publication of economic indicators showing both resilient activity and inflation risk that remains high in the US and Europe. More hawkish comments by central bankers have thus contributed to the sharp increase in sovereign yields in both the US and Europe. Investors’ expectations about Fed tightening have risen, sending the dollar higher versus the other currencies during the month. This rebound of the greenback is also attributable to renewed geopolitical concerns, as one year following the start of the war in Ukraine, geopolitical tensions have grown more acute, in particular between China and the US.

In the euro zone, on Thursday, 2 February the ECB raised, as expected, its policy rates, by 50bp at the start of the month (to 2.5%-3%). At her press conference, Christine Lagarde was less firm than initially expected amid easing financing conditions, leading initially to a sharp drop in European sovereign yields. That said, fears of renewed inflation, confirmed by the February data, have prompted ECB members to take a more hawkish line, as they have mentioned the need to continue tightening. This led to a pronounced rebound in European sovereign yields (nearly 40bp for the German and French 10-year bonds) over the month. In addition to the publication of higher preliminary inflation rates in France and Spain, the rebound of the February PMI activity indices (composite index 52.3 vs 50.7 expected and 50.3 in January), especially in services, added to these concerns. CEOs have said that they want to continue raising their selling prices, especially in services, owing to rising wages. This confirms that second round effects tied to wages are now emerging, exacerbating fears about core inflation. It should be noted, however, that industry has experienced a reduction in inflationary pressures due to moderating prices of inputs such as energy and the improvement of supply chains. Moreover, in order to promote the competitiveness of European industrial companies in the ecological transition, particularly in the face of the American Inflation Reduction Act, the European Commission has presented a plan called the Green Deal Industrial Plan, which will have to be the subject of a consensus between the Member States, with a capacity of €245bn coming essentially from unused funds from the post-pandemic recovery plan.

In the UK, the Bank of England raised its policy rate by 50bp (to 4%). This decision had been expected, but once again it was not unanimous. While investors had assumed that there would be a pause in the raising of key rates, the hawkish statements by Catherine Mann as well as the fact that core inflation (especially on wages) is still high helped drive UK yields higher. Economic activity has also recovered (PMI composite index at 53 vs 49 expected and 48.5 in January), lifting sterling against the dollar and the euro. Finally, as part of the Brexit negotiations, the UK and the European Commission reached a new agreement on the Northern Ireland protocol, which covers the circulation of goods between the UK and Northern Ireland; this should ease tensions between the European Union and the UK government.

In the USA, the resilience of the job market, illustrated by the vigorous acceleration of job creation in January (+517k vs +260k in December), as well as inflation data that began rising again in January, especially the core component (PCE index followed by the Fed at +5.4% yoy vs +5.3% in December) fanned investors’ fears concerning the scale of the monetary tightening, which remains necessary in the eyes of the Fed and contributes to the sharp increase in sovereign yields (+ 40bp m-o-m for the 10-year). While the Fed has slowed the pace of its key rate hikes with +25bp to 4.5%-4.75% at the 1 February meeting, the members of the Fed have since taken a harder line in favour of a more restrictive policy, helping to push the dollar sharply higher. There are growing fears about the persistence of core inflationary pressures, in particular in services. According to surveys, manufacturing and services companies have raised their selling prices in order to pass along higher wage costs, confirming that the wage-price spiral is still a reality, especially as activity remains resilient, especially consumer demand, despite price hikes, as illustrated by the recovery in US retail sales in January (+2.4% in volume m-o-m vs -1.2% in December).

In China, the month of February was disrupted by renewed US-Chinese geopolitical tensions, which weighed on Chinese equity indices (in the absence of any publication of activity indices after the Chinese New Year). One year after the start of the war in Ukraine, the US accused China of wanting to provide arms to Russia, while Beijing has repeatedly said that it believes Washington is exacerbating the Russia-Ukraine conflict.

In commodities, oil prices ended the month slightly higher (Brent at $83.9/bbl), supported by favourable activity indicators and the announcement of a Russian production cut in retaliation to the introduction of a price cap by the G7 countries. Gas prices continued to fall in Europe (the TTF reference price fell back below €50/MWh, its lowest level since November 2021). Finally, industrial metals and gold prices were penalised by the appreciation of the dollar against all currencies.

Completed on 7th march 2023