The Damage is Done

The macro point

Inflation is already here. Take polyethylene, for example. It's found everywhere: in our packaging, water bottles, shopping bags, construction materials, and medical supplies. Today, nearly 50% of global production capacity is either halted or limited by supply issues. As a result, prices are rising. American giant Dow Chemical, one of the world's leading producers, has doubled prices since April 1^st. The pound goes from 0.15 dollars to 0.30 dollars. Not insignificant. Inflation will materialize not only through energy but especially through the destabilization of supply chains.

How will central banks react to this situation? The money market anticipates that they will drastically raise rates to counter the inflationary pressures starting to materialize. In the eurozone, three hikes are expected this year. Roughly speaking, they would react in the same way as during the Ukrainian crisis of 2022. An important point, however, at the time, we were facing both a supply crisis (disruption of access to Russian oil and gas) and abundant demand enabled by COVID savings and wage increases. That's not the case currently. That's why we are skeptical about the rate hike expectations. In the past, central banks have tended not to overreact to oil supply shocks. For example, following the Gulf War (1990-91), only the Bundesbank, due to its absolute fear of inflation going back to the 1920s, raised its key rate. A big mistake!

This doesn't mean that the market consensus is wrong. But it is certainly exaggerated. We will have a clearer idea of the inflationary fallout in one or two months. Until then, we will have to navigate by sight. This will obviously be very complicated for central banks facing strong market pressure, especially those meeting in the coming weeks to decide monetary policy. However, there's good news for major treasurers. Unlike in 2022, the risk of a price-wage loop is near zero on both sides of the Atlantic. When this happens, it's difficult to combat because inflation spreads throughout the economy. Only drastic rate hikes, sometimes pushing the economy into recession, can fight this vicious circle. The challenge is therefore less significant than following the war in Ukraine, even if, at the moment, uncertainty is much higher.

Technical point

Unsurprisingly, the foreign exchange market is torn between energy shock, monetary policy differentials, and geopolitical uncertainty. Our central scenario is based on no action from the European Central Bank (ECB) in the short term, while the American Federal Reserve (Fed) could continue its rate cuts in the second half of the year. Beware, this is not what the market consensus predicts. But it's often wrong.

Across the Channel, several members of the monetary policy committee have adopted a less hawkish tone over the past week than during the March Bank of England (BoE) meeting. Ultimately, the central bank has not abandoned the rate cuts that were planned before the conflict's outbreak. The war in Iran, which could severely affect British growth due to the energy shock, could even provide an additional argument for lowering borrowing costs. In this context, we think that the EUR/GBP should continue to rise with a target of 0.88 in the short term.

The situation is slightly different in Central and Eastern Europe. The economies are more open than in Western Europe. Additionally, they often face a tighter labor market. This is particularly the case of Hungary, facing the energy shock, political uncertainty due to the April 12 elections, and rising wage costs weighing on company profitability. The local central bank will not have an easy task in the coming months.

The supports and resistances shown below indicate the respective low and high points within which the prices should evolve during the week.

Announcements to follow

From a statistical point of view, the week is not busy. American inflation is on the agenda. Typically, the core PCE index is closely watched as it is the preferred measure of inflation by the American central bank. Unfortunately, it will cover the month of February – before the war in Iran. No matter the final figure, it will be of no importance. Finally, American inflation in March is also expected. It will certainly be too early to know the magnitude of the inflationary shock.

The information presented in this publication is communicated for informational purposes only and does not constitute investment advice, an offer to sell, or a solicitation to buy, and should not be used as a basis or considered a motivation to engage in any investment.