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13 February, 2023 - A winter that was not (yet).

Winter has not arrived yet in most parts of Europe, literally and metaphorically. As we experience unusual sunny conditions and a mild winter in central Europe, our thoughts travel to the macro-economic "winter" which has also not come yet. The scenarios that were circulating a few months ago about the region, and which ranged from an outright deep recession to potential shutdowns of factories and production due to oil & gas shortage, seem to have been avoided for now. Europe seems to be enjoying the nice weather, with very few clouds in the horizon, literally and metaphorically. But we chose to remain vigilant. The experiment of the central banks to "drug" the economies with trillions of dollars and euros during the pandemic and then raise interest rates at the fastest pace ever, has no historical precedent to which we can refer and try to understand potential consequences. Only the immediate future (6-9 months) will tell us.

Various FED officials tried to push back on the markets' recent aggressive pricing of a significant change in monetary policy in the next months. Potential rate cuts as early as the summer has been one of the major drivers of markets since the start of the year. And if J. Powell himself in a speech last week did not offer any new information, it was Waller (a voter) who that said excessive inflation is more serious of a problem to have than higher rates and Williams (a voter) who said that the FED has still a lot to do with interest rates. Overall, we have the feeling that markets got carried away after the FED and the ECB meetings which indeed toned down their rhetoric, as they assigned large probabilities to interest rate cuts as early as the summer of this year. This possibility is not actually distant, but if it happens it will be for a reason : recession. So, equities should not celebrate now this scenario (lower rates because of recession), but later and from lower valuations.

Bonds reacted negatively, which also pushed equity markets lower. The US 10-year yield rose by almost 20bp, to 3.70% from 3.50% at the start of the week, while the German equivalent rose to 2.30% from 2.20%. The difference between the 2-year and the 10-year yields in the US, dropped to a new multi-decade low of 80bp, which is considered in-line with deep recessions (see chart of the week).

But the jobs market in the US remains strong. The weekly initial jobless claims were announced at 196k , again below 200k, which are the lowest levels in many years. Usually, the weekly claims have to rise above 400k , for the data to be consistent with a recession. The puzzle of the very strong jobs markets despite the rise in interest rates, the slowdown of retail sales and other macro-economic indicators as well as the daily announcement of companies firing people, is yet to be solved.

In this envirnoment equity markets fell for the week. Nasdaq was the worst performer among the US indices, with a 3% drop, while Europe fell on average by 1%. Chinese equities also dropped by 1%, but at the beginning of this week they are staging a comeback (+1%), despite the negative picture of the US futures market. In terms of sectors, Communications and Consumer Discretionary dropped by more than 4%, but these two were the leading sectors from a performance aspect, since the start of the year.

Nikkei and other media reported that the Japanese government will appoint Kazuo Ueda, as the new BoJ Governor. Mr Ueda is an academic economist and a former BoJ board member. This was a big surprise as he was not in the list of the candidates recently surveyed by Bloomberg. It is hard to know how Ueda will handle the current situation with its severe challenges but Ueda is not considered an outright hawk. He wrote an opinion to Nikkei in July last year that the BoJ should avoid hasty rate hikes. Given that the Bank of Japan is the last remaining central bank among the majors to continue its very easy monetary policy , an appointment (if confirmed) of a rather unexpected person might increase volatility in financial markets.

The German CPI (inflation) numbers showed a smaller-than-expected increase for January. According to the data which were delayed for one week, the headline number dropped to 9.2% on an annual basis vs expectations for a rise to 10.2% from the 9.6% figure in December. On a monthly basis, inflation in January rose by 0.5%, much less than the 1.3% expected by analysts.

The US inflation numbers for January are scheduled for tomorrow, Tuesday 14th. The headline number is expected to have moved down to 6.2% from 6.5% in December, with a monthly change of 0.5%, against only 0.10% in December. This leaves room for positive surprises, as a monthly change of only 0.24% (half of the expected, but double of the previous number) will bring annual inflation lower than 6%, a significant milestone. The core CPI is expected to move down to 5.4% from 5.7% in December.

The USD strengthened again. The EURUSD dropped below 1.0700 after touching 1.10 only a few days ago. The rise in bond yields as well as the fact that the Ukraine situation looks unlikely to be resolved any time soon has made investors jittery again for the common currency.


Chart of the Week :

The US yield curve signals recession ahead.

The above, complicated chart, shows in green line the difference between the yield of the US government bonds for 2 years and 10 years maturities. The "normal" is that the 10-year interest rate is higher than the 2-year, so the 10-2 difference is supposed to by a positive number. This number today is at -83bp, at the lowest level in the last 30 years, as seen in the chart. Even more importantly, every time the difference drops into negative territory as in 2000 and 2006, a recession follows a few months after. Recession periods are shown by the grey areas. Even in 2019, the difference dropped to zero (close to becoming negative) and a recession occured in mid-2020. Admittedly the recession was primarily caused by the pandemic, but who knows what would have happened anyway, as many other indicators were turning lower in late 2019.


• The content of this document has been produced from publicly available information as well as from internal research and rigorous efforts have been made to verify the accuracy and reasonableness of the hypotheses used. Although unlikely, omissions or errors might however happen.

• The data included in this document are based on past performances and do not constitute an indicator or a guarantee of future performances. Performances are not constant over time and can be positive or negative.

• This document is intended for informational purposes only and should not be construed as an offer or solicitation for the purchase or sale of any financial instrument and it should not be considered as investment advice. The market valuations, views, and calculations contained herein are estimates only and are subject to change without notice. Any investment decision needs to be discussed with your advisor and cannot be based only on this document.

• This document is strictly confidential and should not be distributed further without the explicit consent of Kendra Securities House SA.

• Sources: Chart of the Week : Factset, KSH

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