The gap between the two sides of the Atlantic widened in May. After a quarter-point increase in March, the Fed made its biggest hike in two decades in May. The 0.5 point increase set the key rate at 0.75%-1%. By the end of this year, the market expects it to be 2.75%-3%. As for inflation, estimates for April published at the end of May showed a slowing pace to 6.3% year-on-year, 30 basis points lower than the four-decade high in March. The counterpart has already been felt, however: consumer confidence has fallen to a six-year low on future prospects, at a score of 77.5 points. Consumers have become more cautious, especially when it comes to major purchases, such as cars or houses.
Consumers’ morale is low
In Europe, consumer sentiment is not at its best either. Even though it has recovered 0.9 points in the euro zone, the score remains at a ten-year low, if we exclude the brief but violent fall linked to the Covid-19 pandemic. However, the ECB has not yet raised its key interest rate, which is still at 0.5%. President Christine Lagarde has nevertheless accelerated the timetable: a first increase in July is now a virtual certainty. By the end of the third quarter, negative rates should be a thing of the past.
One of the reasons for this is inflation in the eurozone, which is expected to hit another record high in May, at 8.4% (+0.7 percentage points) over a year. A rise in the price of a barrel of crude oil towards 120 dollars is even more strongly felt in the euro zone. In May, the single European currency reached a multi-year low by falling below the 1.04 dollar per euro mark. As for gas, its price remains high, even if there have been no major extremes.
Sovereign debt anticipates rate hikes
The sovereign bond market is anticipating ECB rate hikes, and probably also limiting its President’s room for manoeuvre. Even the German Bund, which is a benchmark for low-risk investment, has reached a record yield since 2014: 1.15% for the ten-year maturity. The gap with riskier countries has still widened: the yield on Italian 10-year debt has reached 3.4%, the highest since late 2018.
And Greece’s is at 3.74%. Yet the fight against the pandemic has put a strain on their finances: Italy’s debt to GDP has reached 150.8%, 15 points higher than before Covid-19. Greece’s debt to GDP even reached a record high in 2020, and still stands at 193.3% at the end of 2021. Fortunately, maturities are longer than during the 2012 debt crisis, and support programmes, notably from the ECB, remain in place.
In the US, which benefits from the dollar’s status as the world’s reserve currency, the yield on 10-year Treasuries is capping at around 3%, the highest level since late 2018. Debt has reached an all-time high of 137.2% of GDP, without the “AAA” rating being challenged by any agency other than Standard & Poor’s, which has given them an “AA+” since 2011.
Supply chains remain tight
In China, the lockdown in Shanghai is finally being lifted, having beaten the odds in terms of its duration. However, we should not expect an immediate return to normality. The unblocking at the port of departure in Shanghai is likely to lead to further spillover to the ports of arrival. Supply chains will remain under very high pressure, as the New York Fed index shows, at more than three standard deviations from the mean value. Nevertheless, after the -1.4% decline in the first quarter, US GDP is expected to rise by 2.1% between April and June, with positive growth (2.3%) over the whole year. In the euro area, on the same basis, GDP growth was 0.3% in the first quarter (+10 basis points compared to the first estimates). But for the next three months, a temporary contraction cannot be ruled out. For the year as a whole, growth of 2.7% is expected, a figure that has been revised downwards.
PMI indices down
The PMI indices were not very positive in May either. In the US, both the industry index (57 points) and the services index (53.4 points) have been lower recently other than in January 2022. The labour market is their main support.
As for the euro zone, the glimmer of hope is rather on the services side, since the 56.1 points mark the second highest score since September, supported by overseas orders. On the other hand, the decline in industry (54.6 points) continues, notably because of rising costs (which companies should be able to pass on to maintain their margins), which is fuelling concerns about the resilience of demand.
