Macroeconomic update by François Duhen - Q1 2023

Q1 2023 saw a return of risk aversion even though growth outpaced projections early in the quarter. Inflation remained stubbornly high (especially the core component), which led central banks to continue tightening policy, and this was compounded by a wave of financial turbulence in March in the wake of the failure of three regional banks in the US and the forced sale of Credit Suisse. The risk aversion was reflected in a fall of European and US sovereign yields in March; this contributed to the resilience of equity markets, which was also underpinned by the economic recovery in China. Contagion from the banking turmoil has been contained (for now) in both Europe and the US as a result of the intervention by policymakers, and the absence of any aggravation of the situation at the end of March fostered a renewed appetite for risk.

In the euro zone, where price pressure (especially core inflation) is still strong (yoy: +6.9% in March; +5.6% for core inflation), the ECB continued raising key rates, with hikes of 50bp to 3-3.5% in February and March. Activity has been more resilient than anticipated (PMI composite at 54.1 in March vs 52 in February), in particular in services, whereas the manufacturing sector contracted, in spite of an improvement in supply chains. More broadly, recession fears continue to diminish. Investors had briefly anticipated that monetary policy would turn less restrictive owing to concerns about a systemic banking crisis sparked by the failure of the US banks and the shotgun wedding of Credit Suisse and UBS, but the ECB reaffirmed its confidence in the resilience of the euro zone banking system. Indeed, regulations have been beefed up in the currency bloc over the past few years, and for now this heightened regulatory oversight appears to have been sufficient to forestall a full-blown crisis. The ECB also reiterated that it has the tools to take emergency measures if needed to maintain financial stability. 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, 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. Finally, in France, as in Germany, social tensions (strikes and demonstrations) and even political tensions (within the German three-party coalition) have grown.

In the UK, faced with persistently high inflation (jumping to +10.4% y-o-y in February vs. +10% in January), the Bank of England (BoE) raised its key rates by 50 and 25bp (to 4.25%) in February and March. Like his European peers, BoE Governor Andrew Bailey indicated that the level of interest rates would be determined by anti-inflationary considerations, believing that the UK banking system was resilient, and that if inflation persisted, further monetary tightening would be favoured by the BoE despite the deteriorating economic outlook.

In the US, the failure of the regional banks Silicon Valley Bank, Signature Bank and Silvergate forced the Fed and regulators to deploy exceptional measures to guarantee deposits and access to liquidity for American credit institutions. More than $300bn in liquidity was injected into the banking system in the space of a week in March. Since then, the signals have been reassuring, since not only do interbank markets remain active and liquidity injections have partially slowed, but also the risks of deposit flight remain contained. Given the financial turmoil and expectations of a less restrictive monetary policy, US sovereign rates fell sharply over the quarter. However, in light of a still very tight labour market (ongoing dynamic job creation), conducive to second-round effects, and persistent inflation (PCE inflation: +5% y-o-y in March; core component: +4.6%), the Fed raised its key rates by 25bp at its two meetings (from 4.25-5% to 4.75-50%). Central bankers nevertheless acknowledged that the toughening of financial conditions induced by the banking stress could lessen the need to raise key rates as high as previously anticipated.

In China, the reopening of the economy is clearly benefitting the activity PMIs, which have rebounded sharply, particularly in services (Caixin services PMI for February and March very clearly in expansionary territory and accelerating), buoyed by the strong rebound in domestic consumption. In addition, geopolitical tension with the United States has increased, notably over the war in Ukraine, one year after the start of the Russian invasion, while the meeting between Xi Jinping and Vladimir Putin has ramped up the differences between the two Western and Eastern blocs. With regard to emerging markets, Lula's government proposed a new fiscal framework with a pledge to reduce the public deficit, while the Brazilian central bank once again kept its key rates unchanged over the quarter.

Regarding commodities, the moderation of energy prices continued this quarter, particularly for gas (almost -40% for the quarter as a whole to €46/MWh), due to favourable weather conditions, efforts to reduce demand and the diversification of supplies. Given concerns related to recession and banking stress, oil prices also fell (Brent crude oil by -9% to $79/barrel), which also reflects the resilience of Russian exports despite Western sanctions. Lastly, China's economic recovery supported the price of industrial metals (copper: +7.5%; aluminium: stable), while gold was strengthened by the wave of aversion to risk.

Completed on 6th april 2023