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Market Insights, June 13, 2022

Each week, our Investment team shares its market views with you !

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L'essentiel

Gasoline prices have hit a new record high. Rising oil prices have, of course, played their part. But the main reason for the recent surge is limited refining capacities. The only way to ease the pressure on consumers’ wallets – apart from state subsidies – will be to reduce demand.

Digital assets dropped sharply after US inflation figures came in higher than expected. Bitcoin broke below the key support level of USD 29,000 and could head towards USD 20,000.

After the first round of France’s parliamentary elections, Emmanuel Macron’s party is neck and neck with Jean-Luc Mélenchon’s alliance, which means Macron may not get an absolute majority in the National Assembly. If this outcome is confirmed after the second round, on 19 June, the president will find it very hard to implement major policy initiatives, such as pension and unemployment reforms.

The ECB lets go of long-term rates

Last week, the European Central Bank (ECB) made tackling inflation its No. 1 priority. It also announced its intention to start tightening monetary policy. It should raise key interest rates by 25bp in July, with a second, 50bp hike on the cards for September if inflation doesn’t settle before then.

The asset purchase programme will also be wound up in July – another much-awaited measure. That means that the ECB will no longer use its balance sheet to control long-term interest rates by buying up European sovereign debt. This will mark a return to normal in monetary policy terms – that is, the ECB will set short-term interest rates but leave it to investors to determine long-term rates  based on their expectations for the economy and inflation.

The reaction on Europe’s bond market was unequivocal. German 10-year rates rose 0.2% in the hours following the ECB’s meeting and ended the week at 1.5%. Long-term rates were already experiencing strong upward pressure in 2022, with German 10-year rates having started the year in negative territory.

This rise in yields looks set to continue, as, unlike in the States, long-term interest rates still don’t line up with long-term inflation expectations. But the decision to stop printing money will have other repercussions for the eurozone.

The asset purchase programme also enabled the ECB to keep control of risk premiums between core and peripheral eurozone coun-tries. Interest rates have already risen sharply in Mediterranean countries, and particularly in Italy, where long-term yields are nearing 4%, making things difficult for the already cash-strapped government.

In 2012, when he was president of the ECB, Italy’s current prime minister, Mario Draghi, promised to do whatever it took to save the eurozone. He’s no doubt crossing his fingers that his successor, Christine Lagarde, will show the same consideration.

US inflation is proving stubborn

The news that inflation picked up again in May dampened hopes that the rise in consumer prices would quickly return to more normal levels. Inflation came in at 8.6% last month, driven up by the increasing cost of services and fuel. The markets corrected sharply on the back of this news, wiping out almost all of the gains recorded over the previous month, when the consumer price index had dropped slightly. The only silver lining is that core inflation, which excludes more volatile components such as energy and food, was down on the prior month.

It’s looking increasingly likely that inflation will ease only very gradually. It may even stabilise at a high level before dropping, probably towards the end of the summer. In the meantime, the impact on the cost of living and on consumer confidence is hard to miss. After the inflation figures were published, consumer confidence indexes dropped to their lowest levels since the 2008 financial crisis, sparking fears that the US economy will slow considerably if inflation persists.

Whatever happens, the effects of the US Federal Reserve’s monetary policy tightening have not yet been felt, and the Fed’s tone is likely to remain resolutely hawkish over the coming months. Stock markets should continue to drop back to the lows recorded in March, at least until there is a clear drop in inflation.

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