Rabobank: Europe And Markets Are Shivering And Trembling

By Bas van Geffen, senior macro strategist at Rabobank

Great news, the G7 Finance Ministers agreed to prevent future supply-chain problems. That might just have to do with the backlash that leaders are starting to face from their electorates, with inflation now the next headache for President Biden. However, aside from exchanging “views on how to promote greater resilience of supply chains and ways to build a more accurate picture of possible future disruptions”, details are quite scarce.

More concrete solutions to the burden of high inflation were provided by the European Commission, which is seeking to alleviate energy price pressures. According to a draft document, the EU is proposing a system of joint gas purchases, and the creation of a strategic gas reserve to avoid future crises like the current one. Bloomberg also reports that it has seen documents in which the European executive wants to prevent gas contracts with Russia from being extended beyond 2049, which is exactly the opposite of what Russia’s been looking for. Still, the EU’s joint-purchase proposal is only in draft, and it will certainly not alleviate potential shortages in the upcoming winter season. In fact, the document suggests that “Member States, through joint cooperation at regional level, should be able to rely on storage in other countries in case of needs”, which is a great idea – unless the entire region is struggling to meet its gas needs.

And with that, German warnings against Russia’s purported plans to invade Ukraine still seem to lack teeth. Chancellor Scholz’ stated the government will “do everything” to ensure that natural gas continues to flow through Ukraine and prevent Russia from using its Nord Stream 2 pipeline to cripple the former Soviet republic’s economy, while Foreign Minister Baerbock raised “security issues” about the new pipeline. However, with Europe in desperate need for additional gas, it is unlikely that Russia will tremble in fear as much as Europeans would shiver of cold if this situation does not de-escalate. The Dutch TTF gas benchmark rose further on these new uncertainties.

Broader markets certainly trembled a bit as well. Shaken by Omicron and the plethora of upcoming central bank meetings –with policy tightening still a theme, particularly at the Fed – the S&P 500 closed 0.90% down. European indices managed to keep their losses a bit more contained, but there still seems to be little appetite for taking on more risk, and Asia has continued the red prints overnight – with Chinese indices also bogged down under new property sector concerns (see below). Indeed, a Bloomberg news poll shows a monetary policy mistake as the main concern of surveyed fund managers, edging ahead of inflation, the next-highest concern on the list.

With the ECB still amongst the most dovish of the major central banks, this pain did not spread to peripheral spreads, though. Italian and Spanish yields outperformed slightly, on the hopes that the ECB will continue to support the European economy and markets amidst the heightened risks. That is not to say that Europe is entirely immune to inflation –even if it is still temporary– and striking the right balance will be key for the ECB on Thursday. In another piece of evidence that input shortages and energy are hitting the continent, yesterday’s German wholesale price index accelerated to 16.6% in October.

Briefly returning to Biden’s headaches, we can add Senator Manchin (D-WV) to that list. The other Joe is still not fully backing the President’s Build Back Better plan, although he remains “engaged” in talks – and he is not opposed to the size of the plan, a whopping $1.7 trillion. While both are due to follow up in the coming days, this puts the passage of Biden’s economic bill before Christmas recess at risk.

Week ahead

As the Fed starts its two-day policy meeting, today’s events are likely of less interest to the markets. Eurostat releases October industrial production, which may show some cooling down of European manufacturing.

Furthermore, investors have once again set their eyes on China’s imploding property sector. Whilst there was some optimism last week that the worst may be over, that narrative has been crumbling in the past few days. This more recent turn of the market was driven by a sell-off in Shimao, a property developer considered to be in a stronger position than Kaisa and Evergrande, both of which are grappling with default. An announcement on Monday by the company that its services unit had agreed to buy another unit of Shimao Group was taken by analysts as a sign that funding stress had forced the developer to shift money from stronger to weaker parts of the business, as Bloomberg reports.

Although one needs to be very careful in making comparisons with other crisis episodes, such as the US subprime meltdown, one of the key lessons of earlier crises is that events tend to come in bursts. The fact that Chinese authorities seem to have shifted their focus towards alleviating pressures –see as last week’s reserve ratio cut– even though their long-term preference is for less intervention, and even as the rest of the world is gradually shifting toward monetary tightening, may actually tell a lot about the gravity of the situation.