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Global Growth More Resilient than Inflation: June 2023 Market Commentary

16 June 2023

Global Macro: Momentum of Declining Inflation

Inflation is moderating in Western economies. In the US, inflation declined to 4% in May, the lowest since March 2021 and less than half of June's 9.1% peak. As a result, the US Federal Reserve decided to pause its interest rate hiking cycle on Wednesday, following ten consecutive increases. We note moderating inflation in the US is largely driven by a decline in energy prices and a slowdown in food inflation.

Over the past 12 months, oil prices went down 40% while the world food index lost 20% (see graphs). We believe the commodity price decline will translate into lower inflation in the months to come.

In developed markets, corporations took advantage of the inflation to re-build their profit margins, lost or compressed during the Covid crisis. Consequently, corporate earnings have surprised on the upside and have underpinned economic growth as well as the equity market rally, with the recent artificial intelligence (AI) hype boosting the valuation of large Tech companies in the US, Europe, and Asia.

This economic backdrop – less negative than expected – increases chances that recession be avoided in the US and last only a few months in Europe.

China is the only major economy with almost no inflation (0.1%) and the only major economy with significant economic growth (over 5%). Chinese equities have underperformed due to a slower-than-expected post-Covid recovery and geopolitical uncertainty. However, growth differentials with other developed markets are in favor of China and should support the Chinese equity market going forward.

We believe the main risks to future global growth and economic recovery are the threatening pockets of Covid variants, geopolitical uncertainties (e.g. the war in Ukraine and US-China tensions), and a possible interest rate hike overshoot from central banks.

Financial Markets:

Equity: In May, US equity performance was largely driven by large Tech stocks (Nasdaq 100 +5.8%, vs S&P 500 +0.2% only). Meanwhile, Chinese equities suffered from disappointing economic data following China’s post-Covid re-opening (HSCEI -8.0%). Fixed Income: The 10-year US yield gained 19bps to 3.64% (vs 10-year German yield -3bps to 2.28%), which contributed to the negative performance of High-Yield bonds in USD (-4.3%, vs flat in EUR). Currencies: The USD gained ground against all major currencies in May amid investor concerns about the global economic outlook: EUR -2.7%, AUD -1.7%, CNY -2.3%, JPY -4.5%, CHF -1.3%. Commodities: Gold and oil prices went down 1.8% and 11.3%, respectively, against the backdrop of a stronger US dollar.

In the US: The year-to-date (YTD) performance of the S&P 500 index (+9%) has been solely driven by 7 stocks: Apple, Amazon, Alphabet, Microsoft, Meta, Nvidia, and Tesla. These large and cash-rich corporations are massively investing in AI research and development. Given the triple-digit YTD stock performance of these stocks, we highlight the risk of an AI bubble in the stock market. High US equity valuations suggest that investors are overly confident in an economic soft landing.

In Europe: Both the Luxury and Tech sectors are driving the YTD performance of European equities (+10%). However, the close-to-zero European growth and the uncertain outcome of the Ukraine war may cap the upside of the equity market in Europe.

In China: The performance of the Hang Seng China Enterprises Index (HSCEI) was negative in May (-8%) as growth numbers following China’s re-opening have disappointed. As China is the only major economy with significant growth (over 5%), no inflation, low equity valuations, low and stable interest rates, and strong government support, we expect the Chinese equity market to outperform the US and Europe over the next 12 months.

With the US interest rate hiking cycle almost over, and given low growth, a large trade balance deficit and inflation, we think the US dollar is likely to weaken going forward.

EURUSD: Trendless but volatile within the [1.05; 1.10] range

Europe has low growth, still high inflation (6.10%), and geopolitical uncertainty with the war in Ukraine. Given this context, where many outcomes are possible, we expect further currency volatility and the EURUSD to trade sideways.

USDRMB: Large economic differentials between the US and China to weigh on the USDRMB

The growth, trade balance, and inflation differentials are in favor of the RMB. Although the stance of Chinese authorities and the People’s Bank of China (PBoC) is about supporting the economy and therefore providing a relatively easy monetary policy with low RMB interest rates (with no inflation), we believe we are near the peak of the USDRMB, currently close to 7.20 and below the resistance of 7.30, and that the bearish trend of the USDRMB will resume, bringing the USDRMB back below 7.00.

In the US, interest rate hikes may be over soon as the Fed is pausing its hiking cycle amid moderating inflation.

In Europe, the interest rate hiking cycle is not over as inflation is the highest among major economies (6.1%).

In line with central banks’ interest rate levels, cash deposit rates and bond yields have increased in USD and EUR.

Short-term deposit rates (<1 year) have reached 5.25% in USD and 3.25% in EUR, and short-duration bond yields (~2 years) have reached 6% in USD and 4.25% in EUR.