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September 18, 2023 -Oops, they did it again.

The ECB managed to surprise markets with a "dovish hike". It raised interest rates again by 25bps, against expectations that they would leave them unchanged, bringing the depo rate to 4.0%. This is the highest level that the ECB has ever set its depo rate since the birth of the EUR almost 25 years ago and follows nearly a decade of zero to negative interest rates. But also surprisingly, the central bank signaled that the interest rate tightening cycle has probably come to an end, a sort of guidance which was also not expected to surface at this meeting. Of course, any negative developments on the inflation front will put this guidance to the test , but for now we can place a significant probability that we have seen the peak of interest rates in the Eurozone. The latest macro-economic data point to a significant deterioration in the economies and actually the central bank itself also cut its GDP forecast and noted further downside risks to growth, as part of its announcements.

The discussion now moves to how long this period of very high interest rates will last. Quoting from the ECB official announcement (the underlining is ours): "Based on its current assessment, the Governing Council considers that the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target. The Governing Council's future decisions will ensure that the key ECB interest rates will be set at sufficiently restrictive levels for as long as necessary. The Governing Council will continue to follow a data-dependent approach to determining the appropriate level and duration of restriction." So we see that the duration of restriction was repeated several times within the context of a few phrases, as the ECB wishes to send the message that no rate cuts are coming anytime soon. This could have implications on the yields of longer-term bonds, as they could continue to move higher, despite the clear message that short-term rates have probably reached their peak.

At the same time, the People's Bank Of China (PBOC) cut the banks' reserve requirement ratio (RRR) by 25bp, for the second time this year. This affects the amount of cash that banks must hold as reserves and aims to help keep liquidity ample and support the economic recovery, which has been much slower than expected after the lifting of Covid-related restrictions. The news came along with some positive macro-economic data out of the country. August Retail Sales rose by 4.6% compared to the same month of last year, while expectations were for +3.1%. Industrial Output also rose by 4.5% on a yearly basis, higher than the forecasts (+3.8%) and showing an acceleration vs last month's 3.7% rise.

The FED will announce its own decision on interest rates on Wednesday. Expectations are for the central bank to keep interest rates unchanged, especially now that the ECB has also started going down the same path. What the market will be looking for is any guidance that the July hike was the last one or another one is coming before year end. Contrary to the Eurozone data, the US economy continues to exhibit remarkable resiliency, although the labor market data have started to roll-over and unemployment to move higher. It is safe to assume the FED is not ready yet to offer a strong indication that we have seen the peak of interest rates, leaving most probably all options open for the next two remaining meetings of the year (November/December). We could of course witness an "ECB-type" of decision, meaning a last hike of interest rates and a clear message that this could be the end. This will be very positive for financial markets.

The August US inflation data were more or less as expected, but with positive details at the Core level. The headline number jumped to 3.7% from 3.2% in July, almost exclusively due to much higher oil prices. The Core CPI rose 28bp, which was the third month in a row of a sub-30bp increase, bringing the yearly figure down to 4.3% from 4.7% in June. Looking into the details, airfares rose nearly 5% in August, after declines of 8% in both June and July. This swing in airfares contributed 9bp more to the core CPI increase in August and looks that it cannot be repeated in the following months, making us believe that the next monthly change should be much less that 0.3%. Among the other components, owners' equivalent rent (OER), one of the more persistent CPI components, slowed notably to a 38bp increase in August from 49bp in July and the smallest monthly increase in two years.

Equity markets were mixed last week. European indices finished with rather strong gains, as US indices posted small losses. Apple's shares weakness continued, albeit at a reduced "speed", spilling into the rest of the Technology group, which finished the week 2% lower. The S&P500 closed the week again below its 50-day moving average. In Europe, UK stocks jumped by 3% and Switzerland's SMI rose by 2.5% higher, outpacing the rest of the region. This pushed the broad MSCI Europe index (which includes the UK and Switzerland) to rise above its 50-day moving average, again. The UK and Switzerland have been the worst performing markets among developed ones, this year, a situation which might change as we are approaching the end of the year.

Bonds had a rather volatile finish, after the ECB meeting. The central bank's unexpected "dovish hike" pushed bond prices higher (and yields lower) as investors cheered the possible end of the interest rate hikes campaign. But on Friday, prices started falling again (and yields rising), as the market focused on the fact that interest rates will have to stay high for a long period of time and the yield curve would have to adjust for that. The German 10-year bund closed at 2.67%, having dropped below 2.60% in the meantime, while the 10-year US yield rose to 4.33% , close to the highest of this cycle. The FED meeting on Wednesday will undoubtedly add to the latest volatility.

Shares of auto-manufacturers were volatile, during last week. First, the European Commission President von der Leyen in her state of the union address ahead of European Parliament elections next year said that an investigation will be launched into Chinese subsidies for electric vehicles with prices being kept artificially low , a clear positive for autos shares. China, of course, replied with a strong statement, expressing its view that such announcements entail protectionism and warned it would damage economic relations, a concern shared by Germany's car industry. And on top of that, the United Auto Workers (UAW) , one of the most powerful trade unions in the US, initiated strikes in various factories of Ford, General Motors and Chrysler (Stellantis) as negotiations with the companies did not lead anywhere. The UAW had demanded a 10% wage increase per year for the next four years, for the factory workers. It is very uncertain how this will end and if history is any guide , similar strikes lasted 1.5 months in 2019.

The Apple event was basically a "non-event". The company presented its new iPhone-15 with some interesting new features and the new USB-C port, for being able to charge the device with universally accepted cords, to comply with EU guidelines. However, the most interesting and disappointing (for investors) news was that Apple did not raise prices for its new model, but only for the (very) high end model. This decision sent shares tumbling again, towards the recent lows (175$). We should highlight that technically the 165$-170$ region should provide ample support for the stock and could represent a good entry point for the long-term investor. Valuation has also come down from 30 times earnings (P/E) to a more decent 26.5x.

Chart of the Week : California's unemployment should be a source of concern.

This is a very interesting chart by Apollo group, one of the largest private equity managers in the world. It shows the difference between California's unemployment and the total US unemployment and although history does not always repeat, it is worth pointing out some interesting facts. Firstly, at times of economic booms, the difference shrinks significantly and almost approaches zero, such as in 1995-200 period or in 2003-2007. Similarly, during the pandemic where Technology played a significant role in our lives, unemployment in California fell significantly, as the rest of the country was bleeding. The second observation we can make is that every time in the last 40 years, California's unemployment vs the US started rising, a recession soon followed (grey areas). Since the FED started raising interest rates early last year, California's companies have been reducing personnel at a fast rate, winding back the extreme hiring of the 2020-2021 era and in an effort to reduce cost. This has led to the spike of the difference in unemployment rates again (far-right part of the chart) and it now remains to be seen if this is a temporary situation or a precursor of something more serious in the US economy.


• 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.

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• Sources: Chart of the Week : Apollo Global Management. photo:


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