Insights into the term structure
Insights into the term structure
8 May 2023
Back to work, but not for long
6 October 2023

Dark clouds on the horizon

If we solely focus on the astounding US labour data, we might be inclined to believe that the economy is strong and no worrisome events could occur. However, this perception is far from accurate. The global economic situation is exceedingly concerning, despite the current stability of the markets.

I will begin with China, the locomotive of the world economy, being the largest exporter and the second largest importer after the United States. China is practically in deflation. Thursday's Consumer Price Index (CPI) figure saw inflation in May year-on-year at 0.1%. Worse was the Producer Price Index (PPI), which slumped to -3.2% year-on-year. This paints a rather gloomy picture.

The story of the Shanghai Pudong Development Bank (SPDB) employee who had his salary cut by 70% makes one think. The news bounced around on WeChat, a sort of Chinese WhatsApp (monitored, analysed, and tracked by the Chinese authorities), provoked a strike outside the bank's offices.

The bank justified itself by saying that the worker's contract was linked to production, and the cut was applied as a result of disappointing results. Other employees also had their salaries cut, albeit by a smaller percentage. Maybe... but what makes my nose twitch is that no such news has ever leaked in China in the past, let alone a strike.

The fact remains, however, that China is in a bad way. But it is not alone.

Germany saw its energy consumption lower than in 2020, the year of Covid-19. Hmmm... Is the industry at a standstill?

A few days ago, the industrial production figure for March was released, showing a decline of 3.4% compared to the previous month. This is the sharpest drop in 12 months and significantly worse than economists' estimates, which predicted a decline of only 1%.

The worrying sign is that industrial production remains below pre-pandemic levels, and expectations are not optimistic. The manufacturing industry witnessed a 10.7% decrease in orders in March, the worst since the significant drop in April 2020. Additionally, retail sales fell by 2.4% in March, marking the worst figure in the Eurozone, and exports declined by 5.7% compared to the previous month, mainly due to poor performance in the Chinese and US markets.

Finally, on April 28, the preliminary GDP figure for the first quarter (0.0% against a forecast of +0.2%) indicated a stagnant German economy. The final figure will be released on May 25. What is certain is that the signals from key German economic indicators are far from reassuring, providing little hope for improvement. In fact, there are concerns that the data could be revised downwards, similar to what happened in February, pushing the Eurozone's leading economy closer to recession.

The only question is: to what extent will this affect the rest of Europe?

I will conclude with the United States and the issue of banks. Even though we no longer hear much about it, the failures of American banks continue, especially among small banks (the failure of the First Republic Bank, which was acquired by JPMorgan, went almost unnoticed but it was the second-largest banking failure). There are primarily two factors contributing to this trend: the relaxation of supervisory regulations for small banks under the Trump administration, and the consequences of an extended period of low borrowing costs.

To mitigate solvency risks, stricter regulations may be imposed on small and medium-sized US banks, leading to tighter credit conditions. Small businesses usually turn to these institutions to apply for loans. According to a report by Goldman Sachs analysts, small and medium-sized enterprises play a crucial role in the US economic and social landscape, accounting for a quarter of gross output and employing approximately 35% of the private sector workforce.

Furthermore, there are the words of Treasury Secretary Yellen, who stated, “Given the current outlook, it is imperative that Congress act sooner rather than later to increase or suspend the debt limit in order to provide long-term certainty that the government will continue to make payments”. The deadline for reaching an agreement is June 1st.

Perhaps not many will recall, but a similar situation occurred in 2011. The failure to reach an agreement during the Obama administration resulted in a 20% decline in the US stock market over the subsequent two weeks.

In conclusion, the world's largest economies have major problems. The economic slowdown is below everyone's eyes (I did not mention US GDP...). The question is: will they be able to avoid a global recession? In the meantime, the likelihood of more substantial rate cuts in the US by the end of the year is increasing.

If we solely focus on the astounding US labour data, we might be inclined to believe that the economy is strong and no worrisome events could occur. However, this perception is far from accurate

David Carli
David Carli
David is a financial analyst with over 29 years of experience (two years as a fund manager) in currencies and commodities. He collaborates with a major European commodity investment company and is the author of several successful books about trading and financial markets.

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