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June 26, 2023 - When the going gets tough, the tough (central bankers) get going.

Central banks keep "playing tough", while we are still receiving data of further deterioration in the economies. And although the FED was the first to acknowledge that they have to stop and reflect, the others have kept on going. We should note that even the FED, which paused, warned the market that it is not done yet and July could bring another 25bp hike. This is also exactly what the J. Powell, said during his semi-annual testimony to the US Congress last week.

As sufficient time has now passed since the beginning of this aggressive rate hikes cycle, the consequences on the economy have already started to show: on manufacturing, housing, credit card delinquencies, higher bankruptcies, bank failures, etc. We have mentioned many times that, unfortunately, the surest way to bring down inflation is through an economic slowdown (or recession) that will hurt demand for goods and services. As this slowdown has already started to take place (Germany is already in technical recession) , it will be interesting to see when exactly the central banks of the Eurozone and the US will decide that enough is enough, when it comes to rate increases. For the moment they keep going.

The Bank of England surprised with a 50bp hike, raising rates to 5%. There was already speculation that the BoE will be more aggressive as it received the shocking inflation data just one day before their meeting, which showed that wage and services inflation refuse to cool down. Now the market assigns a very high probability of another 75bp of increases in total, to bring the terminal rate to 5.75%, before year end. The Bank of Norway got jealous the same day and surprised the market as well, with a 50bp increase, instead for 25bp.

The Swiss National Bank raised rates by 25bp, as expected, to 1.75% and remained hawkish. The central bank remained committed to more hikes if needed, with fears of higher inflation dominating over the fact that the actual inflation in the Alpine country is rather in control. Inflation was just over 2%, according to last month's data. But the most interesting part of the central bank's announcements is the reiteration of their willingness to sell their huge foreign currency reserves, which were accumulated in the early part of this decade, when trying to avoid a further appreciation of the Swiss franc back then. This is all now history. The SNB wants a strong currency, as this strategy keeps the imported inflation down. They have started selling hundreds of billions of EUR and buying the CHF, a process which almost guarantees that CHF will continue to move higher against most major currencies.

And indeed it was a week of much weaker macroeconomic data, supporting the view that as we are entering the second half of the year the deterioration of economic activity could accelerate, posing a big challenge for central bankers:

The weekly initial jobless claims in the US remained at the highest level since before the pandemic. They were announced at 264k, which marked the third consecutive week of 260k+ numbers of unemployment benefits. These numbers are still far less than the 300-350k levels which would show a significant probability for a rise in unemployment to levels closer to 4.5-5.0%.

The June PMI confirmed that the Eurozone is fast slowing down. And although we knew that manufacturing is already in recession , it was the fast deterioration of the services sectors which rang an alarm bell, as it has been an area of resilience, up to now. Not sure that the ECB heard it though. France's Services PMI collapsed to 48.0 from 52.6 in the previous month, falling below the crucial 50 level which means that is showing signs of a recession. Manufacturing remained depressed at 45.5, falling little further below the May level. German manufacturing collapsed further, to 41.0 from 43.2 in the previous month, and we have not seen such levels since the early days of the pandemic back in spring of 2020. German Services also moved lower to 54.1 from 57.2, but they remain for now comfortably above 50.0 But the move lower has gathered pace.

The US Manufacturing PMI dropped further in June to 46.3, down from the 48.4 level of May. Expectations were for the index to remain stable. On the positive side, the Services PMI rose slightly to 54.1 from 53.8, in line with the expectations.

The US leading economic indicators index fell for the 14th consecutive month. According to the agency that tracks this index, the current levels are consistent with predicting a recession in the next 6-9 months almost 100% of the time. To be fair, they have been saying this for the past 6 months and a recession still has to be felt in the US. But the lower the indicators move, the higher the probability of a recession coming sooner rather than later.

The UK inflation numbers surprised yet again to the upside. The headline number remained unchanged at 8.7% y/y in May with expectations calling for a drop to 8.4%. The surprise was largely driven by stronger-than-expected services inflation, particularly items related to travel and recreation. Overall, energy and food inflation declined in May, but their negative contributions to headline inflation were fully offset by a surprise rise in core inflation, as wages rose by a whopping 7.5% on a yearly basis. The core CPI rose by 7.1%, up from the 6.8% in May.

Equities had a rough week, especially in Europe where the main indices were down almost 3%. Swiss stocks managed a little better with the SMI index falling less than 1.5%. The US indices also lost about 1.5% during the week. The 4425-4440 levels for the S&P500 which were flagged in our previous weekly review as very significant resistance look hard to overcome for now as no real catalyst is in sight at least until mid-July (Q2 results - FED) .

In a week dominated by central banks words and actions, bonds managed to finish higher (in price and yields lower). The US 2-year is still trading around 4.75% and the 10-year around 3.75%. German yields dropped for the week and they are now slightly lower than the day before the ECB increased rates ! The primary reason for the rebound of bonds was the bad macro-economic data that were announced towards the end of the week and which increased the probability of a recession again. The other reason is that bond investors are betting that if central banks continue raising rates while the economy is slowing, then a possible recession might be deeper than could have been otherwise. At this stage, it seems that buying longer term bonds (5-7 years) is a win-win situation, whether central banks continue or stop. Of course, if inflation remains sticky after the summer , we would have to revisit this view.

The USD lost significant ground. The EURUSD touched again levels above 1.1000, only to fall towards 1.0950 towards the end of the week, as a risk-off sentiment drove traders back to the USD. In commodities, Gold is fast approaching the 1900$ levels again, failing to capitalize either on the USD weakness or the lower yields or the equity correction. Momentum seems to have been lost for now.

Chart of the Week : US Manufacturing's deterioration should have already triggered a rate cut.

This is the New Orders sub-index for US Manufacturing, which is one of the leading indices showing what the future economic activity might look like. It is more than obvious that manufacturing is moving lower and lower, and can be considered already in a recession. Interestingly, last time such a slump happened (as in 2017-2018), the FED acted with cutting interest rates. And back then, New Orders had just fallen slightly below 50, which is considered the neutral level . This is what the yellow circle shows : the period of the fall below 50 and the rate cut. It is also worth-noting that the rate cut in 2019 came almost 6 months after the final rate increase in December 2018. Now, we are at much lower levels for the sub-index (43) and almost one year below the 50 level. Will the same happen this time around ? Will we have, six months from now, the first rate cut ? The market does not believe so (for now).


• 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.

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• Sources: Chart of the Week : Factset, KSH

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