In the summer of 2022, the pressure is on for central banks, Western and Chinese governments and of course the barometer!
1-Central banks between inflation and threats of recession
Since the beginning of the year, all the major central banks have raised their tone in the face of inflation. The first of them, the Fed, began its rate hike in March 2022 and has not stopped accelerating since. Bond rates have risen everywhere. At 3% in the United States, 1.5% in Germany and 2% in France, 10-year maturities reached symbolic thresholds in June… before correcting. This is because rising inflation, the shock of the war in Ukraine and the tightening of global financing conditions have not been slow to have an impact: in Europe as well as in the US,
leading activity indicators are falling and fears of a recession are growing. Central banks are therefore faced with a profound dilemma: should they continue to normalise their monetary policies at all costs, at the risk of aggravating the economic slowdown, or should they “pivot” and put the movement on hold, at the risk of letting inflation slip away? The first answer will undoubtedly be given at Jackson Hole on 25 and 26 August.
Our US monetary conditions indicator fell to 41 from 84 in May 2021
Source : Montpensier Finance / Bloomberg as at 18 july 2022
2-Europe under energy threat
Since the entry of Russian troops into Ukraine on 24 February, energy prices have soared. The threshold of $120 a barrel was briefly touched at the beginning of June for American light crude before falling back to $100 in the face of fears of recession. In contrast, energy prices in Europe – electricity and gas – continued to rise sharply, driven by the prospect of Russian supply cuts and possible shortages this winter. In the event of an escalation, Eastern Europe, including Germany, would be in the front line. But Italy, also heavily dependent on dependent on Russian
gas would not be spared.
To limit the economic damage, everything will depend on three factors: Moscow’s willingness to restart gas flows after 21 July and the end of the pipeline maintenance period, a diplomatic opening in the conflict with Ukraine allowing for a relaxation of relations with the Kremlin, or finally, concrete progress in all European countries on the measures announced for alternative supplies and energy savings.
3- Emerging countries face food tensions, financial and social tensions
Faced with inflation, the central banks of emerging countries have very quickly raised their interest rates: in Brazil, these have risen by 11% since the beginning of 2021 to 13.25%, in Pakistan, the base rate is 15% and even Poland, the champion of growth in Europe, has raised the interest rate to 6.5%. The pressure is all the greater because the appreciation of the dollar complicates refinancing and, above all, because the pandemic has rapidly increased public debt: the latter rose on average from 57% of GDP between 2015 and 2019 to 67% in 2021. Rising food prices further complicate the situation, particularly in Egypt, Tunisia and the Maghreb as a whole.
The social upheaval in Sri Lanka should be seen as a wake-up call to move forward with debt restructuring negotiations this summer, which are often conducted jointly by the Paris Club – which China has joined – and the IMF.
4- Politicians entangled with inflation, debt and demands
Mario Draghi, Boris Johnson, Emmanuel Macron, Joe Biden, some have had to resign and all are facing complex situations. In most of the major Western countries, the demands of the population are increasing while the inflation/debt pairing threatens economic growth.
In Italy, anything is still possible but let’s hope Mario Draghi manages to get through the “Ferragosto” period before possible elections in September/October.
In the UK, the resignation of Boris Johnson on 7 July opened a new episode in the tumultuous Brexit adventure. The Conservative Party’s choice to replace the iconoclast BoJo is expected to be known on 5 September which augurs a summer of political confrontation across the Channel. Several issues will be at the centre of the debate. Firstly, relations with the European Union, with the thorny issue of the border with Northern Ireland, which was about to jeopardise the trade agreement included in the Brexit.
Secondly, economically, with possible support measures for households that have long been ruled out by the outgoing government. Finally, strategically, relations with the French neighbour, which were severely damaged by Boris Johnson, could be revived.
5- Joe Biden, unpopular in a divided America
More unpopular than Donald Trump at this stage of his mandate! Joe Biden was elected on the promise of reconciling Americans. But nothing went as planned. Physically tired, entangled in endless negotiations with a restive Congress, powerless in the face of fractures within the Democratic Party itself, the American President seems unable to turn things around and is letting the country tear itself apart. he issues of inflation, weapons and the Supreme Court, the political fabric of the country are unravelling. Only support for Ukraine and the rivalry with China seem to be able to create a consensus. But for how long?
Yet the United States remains the economic and strategic pillar of the Western world and of the financial world as a whole. The strength of the dollar, the power of the American economy and army, the solidity of its rule of law, are unavoidable references.
Preserving this is therefore of the utmost importance and all signals will be scrutinised as the economic downturn looms. The conclusions of the commission of enquiry into the events of 6 January 2020, expected in a few weeks’ time, could be the occasion for further turbulence.
6- Globalization still disrupted by China’s zero CoVid
Beyond possible energy shortages this winter in Europe, all value chains that transit through China – the vast majority of them – are disrupted and generate delays and supply failures due to recurrent blockades of activity to comply with the authorities’ “Zero CoVid” policy.
Even if manufacturing and supply chains avoid the Middle Kingdom, the immobilisation of sea freight containers in Chinese ports mechanically increases transport costs to other parts of the world. In addition, the country’s increasing isolation makes it more difficult to establish economic relations with other decision-making centres around the world.
Given the very strong identification of the Chinese political power with the “Zero-Covid” policy, it cannot abandon it ex abrupto. A change will only be possible after a massive vaccination campaign or, in the shorter term, by the gradual classification of the new variants as endemic diseases of lesser severity, allowing restrictions to be lifted.
In the meantime, the world is still under pressure from the ‘waves’ of the virus in China.
7- China: recovery at all costs before the October congress
The recurrent blockages generated by the zero covid policy also have a very significant deleterious impact on the entire service sector, which has been in contraction territory since the beginning of the second quarter of 2022. Beijing is also still struggling with the consequences of the serious real estate crisis that is undermining this strategic industry. Several financial institutions are waiting to recover their debts. Thus, at the beginning of July, the extension of the freeze on the assets of depositors of four local banks in the central province of Henan, which had been blocked since April, led to riots by savers who were fed up with not having access to their money. The continued decline in activity indicators in the services sector and uncertainty about many industrial sectors has led to a rise in the unemployment rate, particularly in the cities. Young people are the most affected: more than 18% of urban youth aged 16-24 are reportedly unemployed. Recovery is therefore necessary to maintain social peace. A 220 billion dollar plan has been announced for infrastructure. The Son of Heaven cannot ignore Confucius for long: “He who governs must take care that there is no shortage of food, that the military forces are sufficient, and that the people give him their trust.” Xi Jinping will ponder this teaching before the October congressional elections.
8- Chine-US economic descalation and strategic tensions
Since Donald Trump’s term in office, tensions have been rising between China and the United States. This summer, the two axes of friction, strategic on the one hand and economic on the other, could evolve very differently, or even diverge.
On the strategic front, positions are hardening. Exacerbated by the stated rapprochement between Moscow and Beijing, the rivalry is crystallising in the Taiwan Strait where the example of Vladimir Putin in Ukraine is being closely studied by Xi Jinping. A large-scale movement seems unlikely before the 20th Congress of the Chinese Communist Party, scheduled for October, but the country’s economic difficulties could lead its leaders to rely more and more on the nationalist card to counter any desire to challenge the current government.
On the other hand, the economic side looks more promising. The rise of inflation in the United States and its impact on the popularity of the Biden administration are pushing the latter to multiply the signals indicating a possible partial lifting of the 25% tariffs on 250 billion dollars of imports from China, decided by Trump. A move in this direction would undoubtedly be welcomed by the markets.
9- The currency wars have resumed
In order to fight deflation, the 2010 decade was a race to lower the value of the world’s major currencies: interest rate cuts, quantitative easing, everything was done to boost the economy and raise the price level. In 2022, this paradigm is reversed. To counter inflation, it is now crucial to influence activity and above all to bring down the price of imports. The currency must therefore be strengthened. So far, the dollar has been the big winner in this new situation, reaching parity with the euro in mid-July, at its highest level for twenty years. But this new currency war is having harmful consequences for many economic players, first and foremost those indebted in dollars, both companies and governments, weakened by increasingly high repayment costs. More generally, the Rise in interest rates generated by this desire to defend the value of its currency against the dollar is weighing on all economies, as the global debt ratio rises to over 350% of GDP. Finally, let’s not forget the case of Japan, the world’s third largest economy and the only country to maintain a very accommodating monetary policy, which has caused the yen to plummet, while the country’s debt ratio continues to rise. Danger!
We must therefore quickly put an end to this deleterious race and put the cooperation of governments and central banks back at the top of the political agenda. Without waiting for the next G20 summit in November in Indonesia, bilateral gestures would be welcome this summer.
10 – The world grapples with the global warming
This summer is shaping up to be an exceptional one for the climate in the northern hemisphere, with record temperatures and severe drought. The hurricane season in the US could also be very busy. Beyond the seasonal variations, the increasing stresses on the ecosystem show the importance of continuing and, above all, strengthening a coordinated global approach both for strategic issues energy or supply of agricultural raw materials and above all drinking water, as well as to deal in the short term with climate shocks that could quickly become large-scale and have a significant economic impact. Investors have a role to play in reconciling growth, decarbonisation and resource preservation.
Investing for a sustainable future is our conviction.
This summer is undoubtedly hot! Let’s hope that companies and their managers, through their ingenuity and dynamism, will be able to cope with this new situation. We believe in innovation, human genius and resilience. Have a great summer!
Guillaume Dard , President & Wilfrid Galand, Strategist Director