Difficult Awakening

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The macro point

When we last parted, the direction of monetary policy in the eurozone seemed clear. The economy was in a slowing phase but there was no need to panic. We return from the summer break with high uncertainty regarding the next monetary policy decision of the European Central Bank, a recession at the eurozone's doorstep, and growing concerns about the Chinese economy. For the euro, all this is an explosive mix explaining the currency's decline in recent weeks. Coming back from vacation is a bit tough. We would have liked to tell you that a bright sun is shining on the global economy. But we would have had to lie to you. The reality is that within two months, the economic landscape has significantly worsened. The cause: restrictive monetary policy conducted in the fight against inflation that's starting to bear fruit and, on a case-by-case basis, the withdrawal of support measures for businesses (in France, for example). The PMI activity indicators for services and manufacturing in August confirm the possibility of a eurozone recession in the third quarter. This risk has been well identified for several months. It now seems to be materializing. Until now, the slowdown was mostly limited to the manufacturing sector. The bad news from the latest PMI survey is that it is rapidly spreading to the services sector (remember that it is the segment that contributes most to growth). The figures published were disastrous in all countries, but the situation is most worrying in Germany. The country faces both cyclical weakness and concerning structural difficulties (lag in digitalization, automotive sector trailing in the energy transition, weak R&D in non-automotive sectors, etc.). One figure shows how bad the situation is: the German services PMI index plummeted to 46.7 last month (a figure below 50 indicates a contraction in activity). Unsurprisingly, the slowdown in the eurozone also affects other economies. Across the Channel, activity is also very much in decline. The UK PMI indices have reached their lowest level since January 2021 (when Covid lockdowns were at their worst). The composite PMI fell to 47.9 in August while it was still expanding in July. If the situation doesn't improve in September (which is unlikely), this supports the hypothesis of a 0.2% contraction in UK growth in the third quarter (significantly more than the level projected by the Bank of England for the same period). Obviously, the slowdown in the economy presents a real problem for central bankers. At their annual meeting in Jackson Hole (in Wyoming, USA), they all unanimously delivered the same message: we must not falter in the fight against inflation. However, their mission has suddenly become more complicated. It was not easy to bring inflation close to the 2% target (only the United States has almost succeeded!). Now, there may also be a need to potentially support economic activity that in some areas is on the brink of recession. The problem is, unless there is a miracle, we know that in economics it is not possible to fight inflation and support growth at the same time. The two objectives are contradictory. In the case of the eurozone, the market is betting on a monetary policy pause. Only 37% of money market participants expect a rate hike in September, compared to 55% before the PMI indicators were released. A pause does not mean the end of the rate hike process. It's more a way to buy time and analyze the extent of the economic slowdown underway. There is a lot of uncertainty about the economic outlook in the coming months. But we already know that the ongoing slowdown will worsen and lead to a significant increase in business bankruptcies. The rise in borrowing costs is starting to hurt. In France's case, business bankruptcies mainly affect very small enterprises (VSEs), and some segments in services like hairdressing or catering. But we see more and more larger companies (including mid-caps) being squeezed both by declining demand, rising costs (not just inputs but also capital), and state-backed loans (they were supposed to be painless, but in reality, often the accumulation of these loans has led to a long-term deterioration of many companies' financial situations). The coming months will be challenging.

Technical point

In the foreign exchange market, there were no major movements in the main pairs last week. The EUR/USD is consolidating in the area around 1.07-08. According to us, the downward pressure remains intact due to significant uncertainties regarding the economic trajectory in the eurozone. Added to this is the debate on the European Central Bank's response to the poor summer figures. It’s hard to see how the euro could return to the 1.12 level (highlighted as a year-end target by many Forex analysts) under these conditions. A decline in the euro against the Chinese yuan is also observed, which is explained by both the poor European figures and probably also by Chinese interventions to stabilize the yuan. It seems clear that at least in the short term, China wants to play the stability card and does not want to rely on a pronounced yuan depreciation to hypothetically boost exports (a significant depreciation has the negative consequence of increasing capital flight). In the coming weeks, it will be important to remain vigilant regarding the direction of the Chinese currency. The supports and resistances displayed below indicate the low and high points within which prices should evolve during the week.

Announcements to follow

On the economic front, the first week of September is rather calm. There are no major indicators (except perhaps the evolution of services in the United States in August on Wednesday). Traders will continue to keep an eye on market expectations regarding interest rate developments (especially for the eurozone where uncertainty is greatest). They will also monitor the macroeconomic situation in China, which caused some jitters during the holidays. The ongoing slowdown is worrisome, and the Chinese government has no miracle solution to reverse the trend. A stimulus policy might be useful but it can also exacerbate the bubbles present in the economy. In short, what is happening in China is also bad news for us Europeans. You will find below the publications and events that should have a major impact on currency price developments.

Day	Time	Country	Indicator	What to Expect?
09/06/2023	16:00	USA	ISM Non-Manufacturing (August)	Previous at 52.7.
09/08/2023	01:50	JAP	GDP 2nd Quarter	Previous at 1.5%.
09/08/2023	08:00	ALL	Consumer Price Index (August)	Previous at 0.3% (monthly change)