In Europe, however, the much-feared energy crisis is less severe than initially expected. Mild winter weather, the diversification of gas supply sources and the efforts of households and companies to reduce consumption have all lowered the pressure on energy markets and removed the threat of forced rationing. In addition, sectors such as the auto-motive and aeronautics industries, which were heavily impacted by global logistics problems during and after Covid, have returned to growth, thus supporting industrial production indices. Caution is nevertheless required. While in 2022 many companies, particularly the most energy-intensive ones, were relatively immune thanks to hedging contracts, their energy bills are likely to rise sharply in 2023, which could squeeze margins and profits. Combined with the tightening of financial conditions as the ECB increases interest rates, a slowdown in investment remains likely. While the inflation peak is behind us, the impact of past price increases will continue to weigh on household purchasing power and thus on consumption, at a time when governments are being forced to further target their support measures. Overall, while the euro zone should in the end avoid a recession, growth should remain sluggish and vulnerable to the slightest shock.
As fears of a strong energy crisis faded during the first weeks of January, risk appetite quickly increased, even for the riskiest assets which benefited from strong demand.
Following a very steep rise in interest rates in 2022, which seriously undermined performance and almost shut down the primary market, fixed income regained its status as a safe haven in 2023 and the interest of investors. The combination of higher interest rates and wider spreads created a very strong appeal for the euro credit market in particular.
After just one month, financial assets’ return on investment was above 15% for the Eurostoxx 50 and more than 2% in the Corporate credit market (compared with losses of around 13% for the two asset classes in 2022). This record performance does not seem compatible with the low visibility of the economy in general (inflation and job market are much stronger than anticipated by the market and central banks).
What about the rest of the year? As we write this, three scenarios remain possible. The first scenario, is a period of stagflation sustained by a very tight labor market requiring a new wave of interest rate rises. This is a possibility in particular because of China’s reopening and the impacts this could have on energy prices in particular. The second scenario is a steep fall in consumption linked to loss of purchasing power (especially in the United States if the real estate market were to fall following a rise in interest rates) leading to a stronger than expected economic slowdown. The first European consumption indicators for December seem much less resilient. Finally, the third scenario of a moderate economic slowdown accompanied by a gradual decline of interest rates with no major impact on consumption or on the performance of the private sector also remains possible.
“The combination of higher interest rates and wider spreads created a very strong appeal for the euro credit market in particular.”
These three scenarios imply radically different monetary and fiscal policies, interest rate levels, credit spreads, valuation multiples and risk appetite levels, and therefore a high level of volatility until the economy reaches its stabilisation point. Because visibility is slow to improve for the key factors of the economy (United States: absorption of excess savings in the second quarter; Europe: sustained drop in inflation not before the fourth quarter; China: impact of consumption recovery on energy prices in the third quarter), static positions are unlikely to yield the best results at the end of the year.
