by François Rimeu, Senior Strategist, La Française AM
Global economic dynamics: resilience or slowdown ?
Is there any real point in writing a newsletter this month? Equity markets were flat over the course of the month, and the same goes for the main bond indexes, despite ongoing high levels of volatility. Looking beyond financial assets, all the uncertainties and risks we face appear to remain unchanged. What about the impact of the current banking crisis on credit? What will be the extent of the macro-economic slowdown caused by the monetary tightening set in motion by central banks? Are fears of a recession truly realistic, given the fact that growth forecasts have been revised upwards to such a significant extent over the last three months?
The past thirty days have nevertheless provided some additional clarity over trends for the coming months, along with some answers to the above questions.
Macro-economic concerns are becoming less acute in both developed and emerging economies, with global PMIs at 53.4 and virtually no region below 50. The service industries are driving growth higher thanks to ongoing strong demand, especially across all areas of tourism. Excess savings from the massive stimulus packages of recent years are the reason behind this strong position, despite negative real wage inflation in most developed regions.
Over the next few months, the fall in inflation in the US will allow real wage inflation to move back into positive territory, which should allow consumer spending to hold up across the Atlantic. GDP figures published in late April seem to support this idea. Similarly, the reopening of China looks set to enable excess Chinese savings to play a positive role in the growth of service industries. With the service sectors accounting for around 70% of growth in developed economies, it is difficult to imagine a recession coming along in the short term, especially with labour markets still in good shape - something that has been proven in the latest data to emerge from the eurozone (unemployment rate at its lowest, employment rate rising, etc).
Although the last few weeks have seen little movement in the prices of major financial assets, it is worth noting the sharp fall in commodity prices, especially oil. We believe weak Chinese demand, rising US production and increasing Russian oil production, despite OPEC + cuts, to be the main reasons for low oil prices, but the general weakness in commodities is also a sign of a slowing economy. The relative weakness of the manufacturing sector is consistent with this scenario. In any case, these dips are good news for the growth of importing economies, not least in Europe, and they are equally positive indicators for the future course of inflation.
Inflation, banking crisis: persistent challenges for economies.
Inflation figures released in April brought little in the way of new information with regard to the US and Europe. While inflation is falling significantly due to very negative base effects on the energy component, core inflation is barely down at all in Europe and also remains very high in services in the US. At present, our outlook is the same as in previous months. The situation is more clear-cut in the United States. With the exception of the real estate component, core inflation is slowing and is no longer far from the Fed's objectives. However, core inflation in Europe remains on the whole more problematic. Wage pressures in Europe are very real, as we can see in public sector pay negotiations in Germany, with negotiated wage increases equivalent to 5% per year for two years.
Finally, the banking crisis is still ongoing, despite the fact that each new bankruptcy is accompanied by observers claiming the worst is over! First Republic was the latest bank to come under market pressure, ultimately having to be rescued by one of the larger banks. At the time of this report, it seems that PacWest is in line for a similar experience at some point over the coming days. In general, the pressure on the share prices of US regional banks continues. All else remaining constant, it is difficult to imagine how this situation might change, as each new resolution protects depositors and senior debt holders but marks the share value at 0.
Even if economic growth holds up, it does not necessarily mean that everything is going well for financial assets. We are maintaining a very conservative bias in general, based on the same outlook. As we are at the end of the cycle, financial conditions are restrictive and central banks will not be as generous as before given the continual high rate of inflation. All this has a negative impact on the distribution of credit (see the ECB's Bank Lending Survey) and increases the likelihood of shocks being in store over the coming months.
May Outlook
The medium-term risks still seem significant to us, even if growth continues to remain resilient. The risk to margins seems to us to be significant and the credit crunch is still underway; since we are at the end of the cycle; the risk of a financial accident is still present, and the consequences of the banking crisis are still unclear. These are all reasons to maintain our very cautious view in general.
