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Weekly market update – It’s still foggy out there

Nathalie BENATIA

In this article:

    Despite solid economic data and an encouraging start to the earnings season, some anxiety over the investment environment remains. We can take our pick as to the reasons why: Forecasts of recession, renewed doubts about US regional banks, inflation proving stubbornly sticky, equity valuations. The list is long.

    So far, everything is (or at least seems) fine

    Results from most business surveys for April are now available. They are strong, particularly in the eurozone. However, some details deserve a closer look for a more complete – and possibly a little less rosy – analysis of the economic situation.

    In Germany, the ifo index business climate measure improved to 93.6, slightly below expectations but its highest level since February 2022. The main driver was the improved outlook, including in the struggling manufacturing sector where industrial companies anticipate increased production.

    The level of uncertainty over these forecasts remains high, however, reflecting a lack of visibility. That should be borne in mind when assessing the purchasing managers’ survey (PMI) results for April in the eurozone.

    PMIs continued to fall in the manufacturing sector, to 44.0 in Germany and 45.5 in France – levels historically associated with a sharp contraction in activity. For the eurozone as a whole, the index was 45.5, an almost three-year low.

    Meanwhile, services sector activity continued to accelerate, with the PMI rising from 55.0 to 56.6, the highest in 11 months. The growth imbalance between eurozone manufacturing and services reached its widest point since early 2009.

    The gap between manufacturing and services is less obvious in the US. The manufacturing PMI crept back above 50 in April (to 50.4, after 49.2) to return to its level of October 2022. Regional manufacturing surveys sent contradictory signals: A sharp rebound in new orders in New York in contrast with a worsening scenario in the Philadelphia and Dallas areas.

    The positive trend in the services sector PMI continued, from 52.6 to 53.7, although this ran counter to the message from other surveys. The Institute for Supply Management (ISM) index posted a sharp and unexpected decline in March to 51.2 from 55.1 in February.

    China growth better than expected

    China’s GDP grew by 4.5% year-on-year in Q1, surpassing expectations. The result was a sharp acceleration from the previous quarter (+2.9%), driven by a rebound in consumption after the lifting of Covid restrictions.

    The positive momentum strengthened over the quarter: After a 3.5% increase in the first two months of the year, retail sales grew by 10.6% in March, year-on-year. Industrial production growth in March reached its strongest pace in five months (at 3.9%).

    These figures reinforce the likelihood that China’s economy will exceed its official growth target in 2023, as we have yet to see all of the impact from Beijing exiting its three-year-long zero Covid strategy.

    Recession expectations remain

    Despite this good news, a majority of market economists still believe a recession in the US is likely. The latest International Monetary Fund (IMF) forecasts point to a high degree of uncertainty and downside risks to global growth, forecast at less than 3.0% this year (with only 1.3% for developed economies compared to 2.7% in 2022).

    What’s happening on inflation and interest rates?

    At the same time, core inflation (ex food and energy) remains too high and there are reasons to fear it could prove sticky. Core inflation in the eurozone surpassed 2% in November 2021 (year-on-year) and has since continued to rise, reaching 5.7% in March 2023. The European Central Bank (ECB) has already warned that, even once it peaks, the battle with inflation will not be over.

    As ECB executive board member, Isabel Schnabel, said in an interview published on 25 April: “We need to see a sustained decline in core inflation that gives us confidence that our measures are starting to work.”  

    Further hikes in policy rates are therefore likely – indeed market pricing already reflects them for the monetary policy meetings scheduled for the US Federal Reserve and the ECB in early May.

    Once the forecasted terminal rate is reached (around 5.25% in the US and 3.75% in the eurozone), the paths diverge. Rate cuts are expected to start in the US as early as September (the famous ‘pivot’ in reaction to a recession). Thanks to the ECB’s rhetoric (‘the battle against inflation is not yet won’), eurozone rates are expected to stay high. Given that central banks do not want to risk being over-optimistic on inflation falling, however, we believe these market forecasts are still too low.  

    While this environment suggests some short-term caution on market direction is appropriate, it does not challenge our geographical preferences, especially our exposure to emerging Asian markets.


    Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience. Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

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