Asset Management: Monthly Macro Insights - July 2023

Investors remain convinced that inflation is likely to come down without much of a hit to economic growth. However, there is not much historical precedent for such an outcome, especially since monetary tightening is not completed, and the effects of higher policy rates are yet to be felt completely.

China and the Eurozone disappoint…

Global economic activity has been marked by unusually large sectoral divergence this year. The goods sector has been weak as the S&P Global manufacturing business confidence index fell to 48.8 in June, signalling a worsening in operating conditions for ten consecutive months. However, investors remained sanguine regarding the economic outlook as the services sector held out.

Regional divergences have also been sizeable. China’s economy lost more steam in June. Calls are growing for more policy support, but officials have been slow to introduce comprehensive measures as provincial governments are facing unprecedented debt burdens following a collapse in land sales, a slowing economy, and the impact of Covid lockdowns over the years. Concerns about the impact of more rate cuts on the yuan is also among factors limiting the scope for support.

Meanwhile, the Eurozone confidence indicators took another step down in June, with both S&P Global PMI and EC sentiment falling, but with a wide sectoral divergence whereas the unemployment rate remained at 6.5 per cent in May, a record-low since the introduction of the euro.

… while US data are mixed

US economic growth has been revised up in Q1-23. What’s more, recent housing data have not only stabilised, but are showing signs of rebounding from recent lows. However, the economic outlook remains murky as the yield curve has inverted sharply, the Conference Board leading economic indicator fell to a depressed level, and the ISM manufacturing index dropped to a depressed 46 in June, its lowest reading since 2009 barring the short-lived plunge during the first months of the pandemic.

Unfinished monetary tightening

June was an extraordinary month for central banks. The Bank of England surprised markets by increasing its interest rates for the thirteenth consecutive time by an unexpectedly large 50 basis points. The ECB raised rates and signalled more to come – most likely as soon as at its July meeting. The central banks of Australia and Canada resumed rate increases after a pause in their tightening cycles, while smaller central banks in Norway and Switzerland continued on their path of raising rates. The Fed chose not to raise rates despite officials increasing their inflation forecasts, but guided markets towards an extended period of higher interest rates with a July hike likely.

Despite repeated forecast errors, investors remain convinced that inflation will recede relatively quickly. Yet, while headline inflation has declined, the stickier components remain persistently high, pressuring central banks to maintain their tightening bias despite a somewhat deteriorating economic outlook, a combination that may well not end as well as investors’ (over)optimistic scenario.

Completed writing on 5 July 2023

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by Marc-Antoine Collard, Chief Economist and Head of Economic Research

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