The start of the year witnessed a demand rise and a conséquent rebound as the pandemic restrictions were gradually lifted. But the war in Ukraine focused all attention, further exacerbating inflation already hitting historical highs. As a result, we expect a tough second half with eroded purchasing power, especially in Europe.
Europe at the heart of all fears
Let's face it: the Eurozone will not avoid a recession in 2022-2023. The end of pandemic-related restrictions supported the service sector for the year's first half, allowing the labour market to find rarely seen levels. However, because euro economies are not very flexible, this surge in demand has been accompanied by a surge in prices, a situation exacerbated by the invasion of Ukraine and the ensuing sanctions against Russia.
Hydrocarbons, electricity, transport, food, and the prices of all basic needs are at an all-time high. So naturally, inflation soars, exceeding 8%. To mitigate it, the European Central Bank has no choice but to raise its key interest rates, which impacts the cost of credit. For states, of course, against the backdrop of the resurgence of tensions in European sovereign debt markets. But also for households.
The 12-month Euribor, which serves as the basis for millions of variable-rate mortgages in Europe, is close to 1% for the first time in a decade. And with the key interest rate hikes planned by the ECB, it should stay on this upward trend. Recall that between the year 2000 and the financial crisis of 2008-2009, the 12-month Euribor was somewhat between 2% and 5%. A return to such levels – which is no longer to be ruled out if ECB rates exceed 1% – would significantly increase the burden of housing-related debt and pose major financial problems for millions of households.
Taken together, these factors represent a considerable threat to purchasing power. At the same time, policymakers are announcing that the energy supply will be problematic next winter. Household confidence is suffering, plummeting to levels rarely seen, making a recession inevitable. Getting out of it will not be easy. The ECB's room for manoeuvre will be limited this time.
The transition to renewables will last for decades, during which Europe will lack abundant and cheap energy sources. Many other factors will have a lasting impact. Europe will have difficulty recovering from the crisis, weakening its long-term growth potential. Ageing, heavily indebted, not very present in the future sectors, betting on technologies that it does not dominate and dependent on China to equip itself to ensure its energy transition as it is today of Russian gas. At this stage, only bursaries at broken prices would justify an investment. We are not there (yet?). We, therefore, no longer invest in the Eurozone, except for the government bond and some individual shares.
The United States has other advantages
The United States may be contracting in the first quarter of the year – a technical recession is not impossible at this stage – but it has other advantages. First, geography matters. Ukraine is far from American borders, and the conflict has a little direct impact on the country. Then, taken together, the three North American countries (the United States, Canada and Mexico) are self-sufficient in energy. There is no need to worry about supplies, especially since the American authorities are proving to be far more pragmatic in using fossil fuels. Third, demand and employment remain strong, so any recession will be limited in time and magnitude. Moreover, having raised key interest rates and reduced its balance sheet, the Fed will have other means to act than the ECB.
On the political front, on November 8, the Democrats will probably lose their majority in Congress, leading to political blockages at all levels and preventing new legislation passage. A situation that the US equity markets have always accommodated well.
But the United States will make the difference primarily in the medium and long term. Their economy is fundamentally flexible and competitive, dominates all future sectors and does not tolerate threats to its hegemony. As is often the case, neighbours will benefit from this dynamism. Therefore, we are investing in the United States, Canada and Mexico.
China is on the move
China is on a completely different track. In 2020, while the West was stimulating and supporting its economy, by all means, the Chinese authorities did not follow suit. On the other hand, with a 5.5% growth target for 2022 and entire segments of the economy on hold in Spring due to the pandemic, Beijing is now putting all the means to accelerate, lowering certain taxes, aids and tax incentives of all kinds, industrial investment, increased use of credit, and low key rates.
Indeed, Chinese growth will not regain the vigour of the past. But in the year's second half, as in 2023, it should show sufficient dynamism to make the rest of the world green with envy. Of course, challenges remain, such as the health of the country's real estate developers. These debt problems affect local government and businesses or Washington's animosity towards any company that might threaten the dominance of its champions. Nevertheless, we continue to invest in China. In the absence of better prospects elsewhere in the world, we are even strengthening our positions.
The rest of the world
It must be said that the war in Europe is far off the list of priorities for the rest of the world. BRICS and most other emerging markets maintain a pragmatic approach, focusing on their supply of essential goods. Like Indonesia, a major nickel producer, some are even well placed to take advantage of this conflict, causing their exports and investment to soar.
Therefore, their main threats come not from the war but from the rise in American rates. They serve as a reference for finance around the world. Their rise translates into higher credit prices for emerging markets. This is a phenomenon which is still accentuated for those whose finances are not optimally managed or whose current account is primarily in deficit. Despite the turbulence, we have exposure to some emerging regions and assets, such as Brazilian government bonds, which remain attractive to us.