The ECB will follow the FED

Buoyed by expectations of a rate hike by the Fed and by very favourable yield spreads, the dollar is once again trading at record highs for 2022 at 1.0350 against the euro on Friday and 1.0065 against the Swiss franc on Monday. Chairman Jerome Powell reaffirmed that the Fed would most likely raise rates by half a percent at the next two monetary policy meetings.  Mr Powell did not rule out going further, clearly indicating his desire to keep inflation under control. However, being aware that this could put a sudden brake on the economic recovery and push the United States into recession, Mr Powell acknowledged that a soft landing would be challenging by saying the Fed was trying to have a “soft or soft-ish landing” – a complicated task either way. The US economy already contracted by 1.4% in the first quarter even though the last quarter of 2021 was particularly dynamic with growth of 6.9%. Since then, the outlook for the global economy has darkened considerably in the first quarter with the war in Ukraine and the COVID outbreak in China. Rising interest rates and rising inflation are contributing to a decline in consumer sentiment, as evidenced by the deterioration in the University of Michigan’s May index, which fell 65.2 points to 59.1 from an expected 64. The US Senate on Thursday confirmed the reappointment of Jerome Powell, who was Joe Biden’s choice for a second run at the head of the US central bank.  The Senate plenary, as expected, voted in favour of Mr Powell by 80 votes to 19. He has been governor of the Fed since 2012 and was appointed to head the institution in 2018 by Donald Trump, succeeding Janet Yellen, who has since become Treasury Secretary in the current administration.

Faced with a similar situation, Christine Lagarde said that the European Central Bank will end its asset purchases at the beginning of the third quarter and will proceed with a first rate hike in the following weeks despite signs of a slowdown in the economy. She has thus opened the door to a first hike on 21 July in the euro area. In this perspective, the monetary policy meeting of 9 June will be decisive for interest rates. Markets are now anticipating three hikes that would bring rates back into positive territory before the end of this year.

In China, the economy is very much affected by the new outbreak and the lockdown in Shanghai. Industrial production has fallen dramatically. After rising by 5% in March, it fell by 2.9% in April. Domestic consumption is also very much affected Retail sales plunged by 11.1%, with some sectors particularly hard hit. In Shanghai, for example, the widespread lockdown meant that no cars were sold for the whole of April! While the Chinese government’s official forecast is for 5.5% growth this year, analysts are revising theirs downwards. Morgan Stanley and Citibank are now forecasting 4.2% GDP growth while Nomura is forecasting 3.9%. Despite this dramatic economic slowdown, the Chinese central bank has refrained from cutting its rates, thus marking the concern of its leaders about the yuan depreciating. It traded at less than CNH 6.4000 to the dollar at the start of the year – compared to a low of 6.8380 last Friday.

The yen has slowed its fall against the dollar and has even recovered somewhat in recent days, falling back below 130 yen per dollar. At its April policy meeting, the Bank of Japan considered it inappropriate to use monetary policy to control exchange rates. The fall of the yen to a 20-year low against the greenback is driving up the cost of raw material imports. Policymakers are concerned about the impact this could have on the fragile economic recovery in the land of the rising sun.

Crude oil prices are recovering after briefly trading below $100 a barrel on hopes of a reopening of the Chinese economy and talks of a European embargo on Russian oil. Meanwhile, the monthly report from the Organisation of the Petroleum Exporting Countries (OPEC) shows that their production increased by 153,000 barrels per day in April, less than the 254,000 barrel increase expected by the cartel. A potential increase in oil demand coupled with a decrease in supply could therefore push oil prices up, even after an increase of more than 10% over the last two weeks. But the surge is likely to be limited as fears of an economic slowdown in the US and Europe as a result of rising interest rates will temper the movement.