In Europe, the price of Nat Gas
Has risen to new highs, alas
As winter comes near
There’s reason to fear
A rebound will not come to pass
As well the impact on inflation
Is likely to add to frustration
Of Madame Lagarde
As she tries so hard
To hide the debt monetization
Some days are simply less interesting than others, and thus far, today falls into the fairly dull category. There has been limited new news in financial markets overall. While the ongoing concerns over the imminent failure of China Evergrande continue to weigh on Asian stocks (Nikkei -0.6%, Hang Seng -1.5%, Shanghai -1.3%), the story that is beginning to see some light in Europe is focused on the extraordinary rise in Natural Gas prices. As a point of reference, in the US, Nat Gas closed yesterday at $5.34/MMBtu, itself a significant rise in price over the past six months, nearly doubling in that time. Europeans, however, would give their eye teeth for such a low price as the price in the Netherlands for TTF (a contract standard) is $22.61/MMBtu! This price has risen nearly fourfold during the past six months and now stands more thar four times as costly as in the US. Whatever concerns you may have had about your personal energy costs rising in the US, they are dwarfed by the situation in Europe.
This matters for a number of reasons beyond the economic (for instance, how will people in Europe afford to heat their homes in the fast approaching winter and continue to feed their families as well?) but our focus here is on markets and economics. Thus, consider the following: Europe remains a manufacturing and exporting powerhouse and is reliant on stable supply and pricing of natural gas to power their factories. Obviously, recent price action has been anything but stable, and given the European dependence on Russian gas supplies, there is a geopolitical element overhanging the market as well. LNG can be a substitute, but Asian buyers have been paying up to purchase most of those cargoes, so Europe is finding itself with reduced supply and correspondingly rising prices.
The first big industrial impact came yesterday when a major manufacturer of fertilizer shut down two UK plants because the cost of Nat Gas had risen too far to allow them to be competitive. Consider the chain of events here: first, closure of the plant means reduced overall output, as well as furloughed, if not fired, workers. Second, reduction in the supply of fertilizer means that the price for farmers will almost certainly rise higher, thus forcing farmers to either raise their prices or reduce production (or go out of business). Higher food prices, which have already risen dramatically, will result in reduced non-food consumption and strain family budgets as it feeds into inflation. Net, slower growth and higher prices are the exact wrong combination for any economy and one to be avoided at all costs. Alas, this is very likely the type of future that awaits many, if not most, European countries, the dreaded stagflation. The ECB has its work cut out to combat this issue effectively while the Eurozone economy sits on more than €11.3 trillion in debt. I don’t envy Madame Lagarde’s current position.
Beyond the macroeconomic issues, what are the potential market impacts? Here things, as always, are less clear, but thus far, we have seen one impact, and that is a declining euro (-0.4%). In fact, all European currencies are falling today as it becomes clearer that economic activity across the pond is going to be further impaired by this situation. It has been sufficient to offset perceived benefits of European economies reopening in the wake of the spread of the delta variant of Covid. However, the upshot of this currency weakness has been equity market strength. It seems that any concerns of the ECB considering tighter policy have been pushed even further into the future thus encouraging investors to continue to add risk to their portfolios. Hence, this morning, in the wake of the ongoing rise in Nat Gas prices, we see European equities all in the green (DAX +0.5%, CAC +1.0%, FTSE 100 +0.45%). Under the guise of TINA, weaker growth leads to continued low rates and higher stock prices. What could possibly go wrong?
US markets are biding their time at this hour, with futures essentially unchanged and really, so are bond markets. Of the major sovereigns, only Gilts (+1.8bps) have moved more than a fraction of a basis point this morning. While risk may be on, it is not aggressively so. Either that, or European banks are back to buying more and more of their national bonds tightening the doom loop that ultimately led to the Eurozone crisis in 2012.
Commodities? Well, as it happens, after a multi-day rally, oil prices are consolidating with WTI (-0.25%) basically holding the bulk of the $10 in gains it has made in the past month. Nat Gas, too, is consolidating this morning, down $0.16/MMBtu, although that represents 3% (Natty is very, very volatile!) With the dollar rocking, we are also seeing weakness across the metals’ markets, both precious (gold -0.75%) and industrial (Cu -2.0%, Al -0.6%, Pb -1.6%). In fact, the only commodity that is performing well today is Uranium, which is higher by a further 8.1%.
Finally, the dollar is king today, rising against 9 of its G10 counterparts with CHF (-0.5%) the laggard and only NZD (+0.1%) able to show any strength today. The Kiwi story has been a much better than expected GDP print (2.8% vs 1.1% expected) leading to growing expectations of a 0.50% rate hike next month. Meanwhile, the rest of the bloc is suffering from the aforementioned cracks in the rebound theory as well as broad-based dollar strength. This strength has been universal in EMG markets, with every currency sliding against the greenback. Thus far, the worst performer has been PLN (-0.6%) followed by THB (-0.5%) and HUF (-0.5%). Beyond that, most currencies are down in the 0.2% range. Interestingly, for both PLN and HUF, the market discussion is about raising interest rates with Hungary looking at 50bps while Poland has called for a “gentle” rise, assumed to be 0.25%. As to THB, it seems the market has been reacting to a rise in the number of Covid cases which is perpetuating the Asian risk-off theme.
We have a full slate of data today at 8:30 with Initial (exp 323K) and Continuing (2740K) Claims; Philly Fed (19.0) and the biggest of the day, Retail Sales (-0.7%, 0.0% ex autos). Tuesday’s Empire Manufacturing data was MUCH stronger than expected, so there will be some hope for Philly to beat. But the Retail Sales data is the key. Remember, this number started to slide once the stimulus checks stopped, and last month we saw a much worse than expected -1.1% outcome. Given the uncertainty over the near-term trajectory of the economy, this will be seen as an important number.
Well, the dollar managed to strengthen despite lacking support from yields, certainly a blow to the dollar bears out there. The thing is, against the G10, I continue to see the dollar in a range (1.17/1.19) and will need to see a break of either side to change views. If forced to opine, I would say the medium-term trend for the dollar is gradually higher, but would need to see the euro below 1.17, or the DXY above 93.50 before getting too excited.
I will be out of the office tomorrow so no poetry until Monday.
Good luck, good weekend and stay safe