On Wednesday June 15, the American central bank (Fed) decided to raise its key rates by 75 basis points, reported Bloomberg, to fix them in a range between 1.50 and 1.75%. Supposed to calm the inflationary spiral, this choice will not be without consequences. This is the strongest monetary tightening since 1994.
Earlier, the European Central Bank (ECB) had indicated that it would end its program of purchases of long-dated bonds in the markets, and that it expected to raise its interest rates in July by 25 basis points. First increase since 2011!
The Fed pulls the handbrake
The median of the forecasts of the members of the Fed’s monetary policy committee (the FOMC, Federal Open Market Committee) now expects a target key rate of 3.4% at the end of the year, and 3.8% in 2023. Their March forecasts placed it at 1.9% in December 2022. In order to grasp the extent of the tightening of monetary policies, let us recall that last summer, the markets were anticipating the first rate hike in… 2023.
« Tighter financial conditions should temper demand “said Jerome Powell during a press conference. The Fed Chairman also specified that a further hike of half a point or three-quarters of a point was highly plausible for the end of July. Rates could start falling from 2024.
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The Federal Reserve is therefore determined to conduct its monetary tightening policy with a view to limiting inflation, which is very poorly received by the population…as the mid-term elections are approaching.
Controlling galloping inflation: does hope give life?
On the other side of the Atlantic, the rise in consumer prices reached an annual rate of 8.6% in May, and accelerated further in June. The benchmark index (CPI) rose 1% after rising 0.3% in April, Bloomberg points out.
In the Eurozone, inflationary dynamics reached an inflationary record of 8.1% over one year in May, reports the Financial Times. An unprecedented since the introduction of the single currency. A rate four times higher than the 2% target assigned to the central bank.
With 5.2% on an annual basis, the French figure may seem less bad than that of neighboring countries, but this result is in reality due to price shields, particularly for gas and electricity, which have limited inflation in the ‘hexagon. A state distortion of the price structure, which resulted in more than twenty billion euros of additional expenditure for energy alone, leading to a further increase in the public debt. It should be noted that this type of measure only shifts the problem over time.
The bond market in turmoil
« Here we are. We can say that we are witnessing a bond crash said Jean-Marc Delfieux, head of bond management at Tikehau Capital, following the sharp adjustment made to risk-free rates and the credit risk premium.
Unsurprisingly, the week was therefore eventful on the bond markets (which weighs in euros 2,775 billion). With extremely high volatility, including short-term sovereign debt.
« The stock market, despite the sharp drop in recent days, is still clinging to valuation multiples which are far from being settled, even though companies have not yet revised their earnings outlook downwards “, reports The Tribune.
As in 2010, the Eurozone bond market is again showing alarming signs. The key indicator of this market is the interest rate on ten-year government bonds, considered the most secure financial asset. However, following the same pattern that occurred a decade earlier, the borrowing rates of the various Member States of the European Union are starting to diverge again.
The gap has widened particularly since the European Central Bank announced that it was ending its purchases in July. A rate differential that means it will be riskier to lend to some countries than to others. That said, in Europe, countries like Germany – an economic heavyweight in the Eurozone – have proportionally much less need to borrow than Greece, Italy or France, since it does not systematically resort to public deficit and that its need for refinancing is low, its debt relative to the size of its Gross Domestic Product being one of the lowest.
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A contrast with states like France, which today, even in times of growth, do not repay their debts, since their debt ratios increase without ever falling. In reality, they are content to roll over this debt, not with a view to financing investments, but to meet current expenses…
Moreover, apart from the fact that the ECB has not yet started the normalization scheduled for July, it is once again accelerating its monetary creation against a background of installed and growing inflation, leading to generalized over-indebtedness… Consequently, even if the ECB has announced speeding up the design of a new instrument for anti-fragmentation of the euro, the effectiveness of which can already be questioned (a solution for an insoluble problem?). As long as the Fed holds its line, the euro will continue to weaken. So when is the crash?