Inflation dynamics peaked

The Fed says it is ready to tolerate a downturn in the economy, because the risk of recession is currently very low.

Inflation has settled more durably than expected at very high levels, largely as a result of soaring energy prices. This dynamic probably reached its peak in March and should slow down significantly from April. In question, the remarks of the President of the Fed, Jerome Powell, who has just announced measures much more restrictive than expected in order to curb inflation. To this end, the Fed says it is ready to tolerate a downturn in the economy, because the risk of recession is currently very low. According to the US central bank, the conflict in Ukraine increases uncertainty, but is clearly not one of the reasons that could justify abandoning the tightening of monetary policy.

Overall, the financial markets showed remarkable calm on the announcement of these changes, as well as in the face of the persistence of geopolitical tensions. Equities even rose slightly. This behavior illustrates in our view the strength of the technical factors in the market. US and European long-term rates continued to rise, albeit in an orderly fashion and in line with expectations. The simultaneous continuation of the flattening of yield curves also indicates that inflation expectations remain subdued, that no recession is expected despite the slowdown in the economy, and that central banks therefore have the situation under control. .

At the moment, the financial markets are anticipating many adverse events, including the rise in rates and the postponement of the fall in inflation. In this context, positive surprises are even possible in the short term. However, prices do not factor in the possibility of a recession during the second half. In this respect, great attention should be paid to potential red flags. One of them is the pronounced flattening of the US yield curve between the two-year and ten-year maturities. Nonetheless, currently very high US two-year yields price in the virtual certainty that Fed Funds will settle at 2% by the end of the year, so the low level of the differential over yields to 10 years does not necessarily constitute the harbinger of a recession, but rather reflects arbitrage positions in reaction to the comments of the Fed.

In the past, geopolitical crises have had little long-term impact on the global economy and financial markets. In addition, many structurally positive factors remain at work: high household savings, large new orders in industry, the resolution of problems with global supply chains, low inventory levels and the rebound in the labor force participation rate in the United States and the strong credit impulse in the private banking systems. So far, the asset and currency markets have reacted relatively weakly to the slowing economy and the tightening of monetary policy in the United States and Europe. As a result, the global financial system is still balanced and broadly stable, despite market volatility.

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