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US Headline inflation (CPI) is down to 5% year on year from 6% a month earlier, with energy helping pull it down in the right direction. Meanwhile the Producer Price Index (PPI) came out at 3.2% at the end of March versus 6.4% in February and 8.9% at the start of the year. Will this declining trend be sufficient for the Fed to pause rate hikes? For the time being, the Fed deemed a one quarter of a percent increase sufficient, in line with market expectations. The Fed could do more if it wasn’t for the bank failures we are witnessing and the weakness of some regional US banks resulting from sensitivity to rate hikes. While rates have gone up, banks have failed to increase the credit interest on deposits, leading customers to seek higher yielding money market alternatives. Banks would have to cut their margins to retain the deposits, which they are not willing/able to do and therefore have less cash available to lend. On top of that, banks are increasingly cautious about the economic outlook, resulting in tighter lending conditions. To us, there is a real risk that the credit crunch could have a significant negative impact on the economy. In the United States, job openings are going down more than expected and jobless claims are going up, but wages remain at high levels. At this stage, there is no obvious sign of a negative impact on consumption that could translate into the prospect of a recession. Meanwhile, in Europe, figures are gloomier, with weak consumer confidence, weak economic growth, and much higher inflation. EU headline inflation (CPI) is still at 7% (no change from previous month). PPI is also on a downward trend, but, at 6%, still practically double that of the US. Somehow Purchasing Managers' Index (PMI) measures seem healthier, however a large divergence between services (indicating an expansion) and manufacturing (indicating a contraction) can be observed. In this context, the ECB decided to increase rates by a modest 25 bps, but unlike the Fed, does not intend to pause. China is experiencing amazing growth so far this year with the GDP figure coming out at 4.5% year on year (compared to 1.56% for the US and 1.32% for EU), with services leading the march over manufacturing. The issue with manufacturing is that while interior demand is healthy, it is less true for demand from Europe and the US. The positives from the China reopening are the normalization of supply chains (freight lower than pre-covid levels), increasing exports from Europe (namely Germany) and tourism (in particular luxury). Our summary recommendations For the reasons listed in the third paragraph (credit crunch), we are even more weary of the High Yield space where the upcoming challenges are even more amplified than the corporate investment grade credit. Credit card interest rates being at all-time highs (average over 20% in the US), the first signs of trouble are appearing in the form of rising credit card delinquencies, leading us to avoid any sort of credit asset backed securities (ABS) or collateralized loan obligations (CLO) in favor of quality investment grade bonds and convertible bonds. Despite this mixed bag of news and the uncertainties ahead, equity markets don’t seem fazed and continue to go up, and volatility (VIX) is at its lowest in 17 months. Therefore, we favor holding cash (treasury bills) as dry powder to be deployed opportunistically.
Chart of the month This graph shows the dramatic slowdown in loan and money creation in the US, but the observation is also valid to a lesser extent in other developed markets, resulting in immense liquidity pressure on banks.
Source: Bloomberg
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