Macroeconomic update by François Duhen - June 2023

May was marked by volatile asset movements, relating to negotiations over the federal debt ceiling in the US and the prospect of a default risk should the US Treasury be unable to meet its commitments in June. However, the White House and the Republican opposition reached an agreement to suspend the debt ceiling at the end of the month, in return for a limit on budget spending. Furthermore, despite concerns about banking stress and the situation of US regional banks, central banks on both sides of the Atlantic continued their monetary tightening. While Fed members hinted at a pause in rate hikes at their next policy meeting, despite the still-slow normalisation of the labour market, their counterparts at the European Central Bank (ECB) reiterated the need for a more restrictive policy in the face of persistent inflation. Economic activity continued to show signs of slowing, particularly in the manufacturing sector penalised by sluggish demand. In China, the weakness of manufacturing activity weighed on the economic recovery and on commodity prices, particularly oil prices.

In the euro zone, the ECB raised its key rates by 25bp. Although the pace of rate hikes has slowed (from 50bp to 25bp), the members have nevertheless reiterated the need for further hikes in view of persistent inflationary pressures, particularly core inflation. The ECB has also announced its intention to stop reinvesting all the bonds held under the historical asset purchase programme (APP), due to mature in July, which will increase the amount of securities not reinvested from the current €15bn per month to an average of almost €30bn in H2-2023. Moreover, according to the Bank Lending Survey, the tightening of bank lending conditions intensified in Q1-2023 in the euro zone, as a result of monetary tightening and banking stress. European sovereign yields, which initially rose over the month, returned to close to equilibrium, due in particular to the prospect of an economic slowdown and the slowdown in inflation, largely due to lower energy prices. This is also due to the slowdown in growth, as confirmed by the fall in May's preliminary PMIs, even though the latter show a growing divergence between the expanding services sector and the manufacturing sector, which is more in contraction territory, penalised by flagging demand. In this respect, Germany has entered a technical recession (two consecutive quarters of sequential growth contraction) following the revision of its growth in Q1-2023 (-0.3% q-o-q after -0.5% in Q4-2022).

In France, inflation slowed in May (+5.1% y-o-y vs. +5.9% in April), while Insee's business climate index surprised on the downside (100 vs. 102 in April), reflecting the worsening economic outlook in both industry and services. In addition, the government presented its "green industry" bill, aimed at accelerating the decarbonised reindustrialisation of the French economy and protecting companies facing competition from those in more polluting countries. This plan, which is intended to be the French response to the American Inflation Reduction Act stimulus plan and whose outline has yet to be defined, would include measures such as a tax credit to encourage investment in the energy transition and subsidies for industries.

In the UK, the Bank of England (BoE) raised its key rates by 25bp to 4.5%, in a decision voted by seven of its nine decision-making members. The BoE also significantly revised upwards its inflation and growth forecasts, no longer anticipating a recession. British growth remained stable in Q1-2023 (+0.1% q-o-q, stable compared with Q4-2022). Despite signs of normalisation in the labour market in March (slowdown in wage growth, rise in the unemployment rate), core inflation in April surprised on the upside, accelerating at both annual and monthly rates (+6.8% y-o-y vs. +6.2% expected and +6.2% in March). Sovereign rates rose sharply, as did the sterling against the euro, in anticipation of a further tightening of BoE policy by Governor Andrew Bailey.

In the US, the White House and the leader of the Republican majority in the House of Representatives, Kevin McCarthy, reached agreement at the end of the month to suspend the federal debt ceiling until 2025, i.e. after the presidential elections in November 2024, in return for limited public spending in the 2024 and 2025 fiscal years. The Congressional Budget Office, a non-partisan body attached to Congress, has estimated that the budgetary savings from this agreement will reach $1,500bn over 10 years. This accord thus removed the risk of a US sovereign default as early as the beginning of June, a fear that had caused volatility in financial assets. Volatility at the start of May was also fuelled by renewed fears about the situation of US regional banks, notably First Republic, which is facing a wave of mistrust on the stock market following a substantial fall in its deposits in Q1-2023, and is to be acquired by J.P. Morgan. According to the quarterly bank lending survey (SLOO), bank lending conditions tightened further in Q1-2023. This did not prevent the Fed from continuing to tighten its monetary policy, raising its key rates by 25bp (to 5-5.25%) at the start of the month. In its press release, however, the Fed indicated that rates were no longer set to rise, and several members shared the scenario of a pause at the next meeting in June. However, labour market statistics showed that tensions were still high and normalisation slow (wages accelerating, dynamic job creation) and inflation, particularly core inflation, accelerated in April (core PCE inflation +4.7% y-o-y vs +4.6% in March). Some Fed members even spoke of the need to continue raising rates, particularly in view of the ongoing rebound in the property market. These factors contributed to a rise in US sovereign yields in May, particularly for short maturities, and to an appreciation of the dollar against the euro.

In China, the scale of the economic recovery remained measured in May, weighing on Chinese equity indices and the yuan. Manufacturing activity continued to contract, while the service sector expanded further, according to the official PMI for May. Price momentum also remained very moderate, with virtually stable inflation in April (+0.1% y-o-y; -0.1% m-o-m), while producer prices fell again.

In terms of commodities, the difficulties in China's manufacturing sector weighed on oil prices (down 8% sequentially to close to $70/b), a trend amplified by high Russian exports. Weak Chinese demand also affected industrial metals and gas prices. In Europe, the benchmark price for gas continued to fall (-30% at a price below €30/MWh) due, among other things, to stocks above their historical average, abundant supply and rising electricity production from nuclear and renewable energies.

Completed on 12th june 2023