For several months now, risks have been increasing in the United States. The banking crisis is dreading water. US banks with less than USD 250 billion in assets are not considered systemic and therefore are theoretically not too big to fail by US standards. Yet these banks account for 80% of commercial real estate loans and provide about half of all consumer and non real estate loans. The good news is that this crisis, by causing credit rates to rise, is in a way substituting for a further increase in the central bank rate, slowing the economy and consequently inflation. This is exactly what the Federal Reserve (Fed) has been trying to do by raising rates. This tightening effect, coupled with a slowdown in job creation and the first signs of weakening core inflation1, leads us to believe that the Fed’s limit has probably been reached. After ten consecutive rate hikes, policy rates are likely to have peaked, having risen from 0% (lower bound) in early 2022 to 5% on 3 May.
In addition to this US banking crisis, there is now the fear of the US debt ceiling. Janet Yellen, Secretary of the Treasury, has stated that a US default on its debt would lead to “financial and economic chaos”, while the Republican opposition still refuses to raise the debt ceiling without drastic cuts in government spending. This is not a new story and it comes up a bit like the tale of the boy who cried wolf. Indeed, this recurring procedure has been initiated 78 times since the early 1960s. After collecting less taxes than expected this year, the US could hit the debt ceiling as early as 1 June. Uncertainty around the ceiling has consistently been unfavourable to the dollar and a source of volatility. In 2011, the S&P rating agency downgraded the US from AAA to AA+ and justified its decision by the impact on “political risk” of the country taking insufficient measures against its budget deficit. At the time, its debt was half of what it is today (USD 14.5 trillion vs. USD 31 trillion). Even if the risk is real this is the first time since 2008 that we have seen such tension on the US CDS - it is quite probable that a last minute agreement will be found.
The other ceiling that is likely to be raised by the end of the year will be at the COP28 in Dubai and concerns the 1.5 degree threshold for limiting temperature increase over preindustrial levels. It was set in 2015 during the Paris Agreement to combat global warming at the COP21. Nevertheless, political action in advanced economies has never been so strong for the energy transition, both in the US (IRA) and in Europe (REPowerEU).
In this context, our macroeconomic scenario remains constructive. While we were more optimistic than the consensus at the beginning of the year, it is now the market consensus that has moved closer to our forecast. We do not see a recession in the US, only a modest and temporary contraction in activity in the second half of 2023. The global economy will be driven this year by China and India, which will account for half of global growth. Inflation should continue to normalise.
We have moved from a negative interest rate environment known as “TINA” (there is no alternative to stocks) to “TARA” (there are reasonable alternatives to stocks) because this new high rate environment is now conducive to low volatility high yielding short term or secured solutions. This is good news for investors. The market adage says “sell in May and go away” maybe this year May will be the month of opportunity?
I hope you enjoy reading this issue, in which we take a closer look at the macroeconomic divergences within the Euro Area, but also between the US and China, and their impact on our various asset classes in a context of still significant uncertainty.
Delphine DI PIZIO TIGER
Global Head of Asset Management
Monthly House View, 19/05/2023 - Excerpt of the Editorial
May 19, 2023