Macroeconomic update by François Duhen - May 2023

After a wave of financial turbulence following the failures of US regional banks in March, the situation improved in April after the response from the authorities. This action led investors to factor in the likelihood of central bank policies turning more restrictive, which contributed to the rebound of sovereign yields. In the absence of monetary policy meetings, the statements by members of both the Fed and the ECB in favour of ongoing monetary tightening to combat inflation also fuelled this trend. That said, ongoing fears about regional banks (especially First Republic), the prospects of an economic slowdown and growing concerns about the negotiations to resolve the US debt ceiling issue have had an impact on risk appetite. Finally, in China, the economic recovery continues, driven by domestic demand, although doubts about the scale of this rebound have not been erased, which has weighed on raw materials prices.

In the euro zone, as concerns about the situation of European banks have eased, ECB members have been speaking out in favour of continued monetary tightening, in particular key rate hikes, in order to limit core inflation, which is considered too high (+5.7% in March yoy vs +5.6% in February). The accounts of the latest meeting of the ECB, on 16 March, which were published in April, reveal that while a large majority of the members had then recognised the need to lift key rates by 50bp, the episode of banking stress had nonetheless prompted some of them to take a cautious stance. In this context, economic data continued to demonstrate the resilience of European growth in Q1 (+0.1% sequentially vs. -0.1% in the downwardly revised Q4), which masks disparities between the dynamism of Italy and Spain (+0.5% sequentially) and the stagnation of the German economy (+0%), penalised by its manufacturing sector. The preliminary PMI indices for April in the euro zone show a grtowing divergence between the services sector, which is expanding strongly, and the manufacturing sector, which is contracting due to the drop in demand.

In France, growth returned to positive territory on a sequential basis in Q1 (+0.2% vs. zero growth in Q4-2022) driven by a rebound in foreign trade (strong rise in transport exports), while domestic components remain in difficulty. Inflation accelerated in April (+5.9% year-on-year vs. +5.7% in March) due to a rebound in energy and service prices. Note also that rating agency Fitch downgraded France's sovereign rating from AA to AA- (the outlook was lifted from negative to stable), mainly due to reservations about the public finances trajectory and the social context following the enactment of the pension reform, which complicates the government's reform prospects.

In the UK, persistent inflation (+10.1% y-o-y in March vs. +10.4% in February), including energy and food, and accelerating growth in regular pay (+6.6% y-o-y in the three months to February) led to a substantial appreciation of UK sovereign yields against the backdrop of expectations of the Bank of England tightening monetary policy. According to the April PMI, the manufacturing sector continues to contract while the services sector remains buoyant.

In the US, the trend for financial assets and confidence of economic agents remained closely linked to the state of the banking turmoil. Sovereign yields were buoyed for a time by: (i) still high inflation (core inflation accelerating to +5.6% y-o-y in March) and a labour market that is still conducive to second-round effects, leading Fed members to talk about the need for further monetary tightening; and (ii) stabilisation of banking stress (more stable bank deposits, and banks using the Fed's exceptional liquidity measures less. However, the rise in sovereign rates was limited at the end of the month by fears about regional banks, with the bankruptcy of the First Republic bank, by concerns about growth, as well as by the question of raising the ceiling on the US federal debt and the risk of a US default, contributing to the depreciation of the dollar against the euro (-1.1% m-o-m). In Q1 2023, US growth slowed compared with the previous quarter (+1.1% at an annualised sequential rate vs. +2.6% in Q4-2022), penalised by investment, which slowed significantly, while consumption remained robust despite a more uncertain environment. In addition, with the federal debt ceiling reached in mid-January, and without an increase or suspension of the ceiling in Congress, the Treasury may be unable to meet its commitments from the beginning of June. A proposal to raise the ceiling in exchange for substantial cuts in government spending was passed in the Republican-majority House of Representatives, without the consent of the Democratic majority in the Senate.

In China, the publication of Q1 growth confirmed the extent of the rebound of the economy (+2.2% q-o-q), driven by domestic consumption in services as shown by the rise in retail sales for March. The recovery is essentially in the services sector (as reflected in the Caixin PMIs for March), with consumer and producer prices remaining very moderate, while industry is experiencing a limited recovery given the weakness of global demand. In addition, geopolitical tension continued: in retaliation for the meeting between the president of Taiwan and US deputies, the Chinese army organised military exercises in the Taiwan Strait.

In terms of commodities, at the beginning of the month, OPEC countries announced production cuts of 1.16 million barrels per day as of May (plus the extension of the 500,000 barrel/day cut in Russian production until year-end), while oil prices were volatile (despite a return to $80/barrel at the end of the month) and trended in line with the uncertainties related to global growth. Industrial metals prices also fell due to doubts about China's economic momentum, while European gas prices continued to decrease to €38/MWh in light of weak demand as the period of replenishing reserves for next winter begins.

Completed on 12th may 2023