Rabobank: The Fate Of Eurozone Fragmentation Is In The Hands Of Putin

By Jane Foley, head of FX research at Rabobank

Maintenance?

EUR/USD has edged lower, to just a whisper away from parity.  The move coincides with yesterday’s closure of the Nord Steam 1 pipeline for maintenance.  This transports around 55 billion cubic metres of natural gas every year from Russia to Germany, under the Baltic Sea.  The maintenance is scheduled to last for ten days.  Politicians, investors and speculators see risk that Putin may not turn the taps back on in time or that a reduced supply could come back online as the economic war between Russian and the West and its allies intensifies.  If the scheduled maintenance of the pipeline is extended it would undermine the ability of Europe to store gas in preparation for winter. The result could be even higher energy prices or, potentially rationing for heavy industrialised users. In turn this could means job losses in Europe and recession. Not only does the latter imply that the window of opportunity for the ECB to hike rates would be limited, but it also increases the likelihood of fragmentation issues coming to the fore within the Eurozone. All of this spells out a why the EUR has been under pressure. The fact that last week’s better than expected US payrolls report has underpinned the view that the Fed will hike rates by 75 bps later this month is only serving to enhance the pressure on EUR/USD.

Comments from Atlanta Fed president Bostic have highlighted his confidence that the US economy can cope with another large interest rate hike.  Bostic, who does not have a policy vote this year, said that he “would support a 75 bp point” increase. By contrast, however, Kansas City Fed President George warned that “moving interest rates too fast raises the prospect of oversteering”. The market is focused on tomorrow’s release of US CPI inflation data as well as earnings season for more direction.

Adding to the worsened environment are concerns over a resurgence of Covid outbreaks in China.  Various cities across the country have reimposed restrictions in an attempt to quash the more infectious variants that have become familiar in the west.  As of yesterday, it was reported that eleven cities are now under full or partial lockdowns, impacting a reported 114.8 mln people.  The restrictions will work their way through into the economy in the form of higher prices and slower levels of activity and, through supply chains, the inflationary impact will be transmitted around the globe.

In addition to boosting the USD, risk-off sentiment is weighing on stock market futures this morning.  In step with this, US treasury yields have pushed lower, and commodities are generally also under pressure.  The price of Brent crude is weakening this morning, though it is holding above its recent lows.  Overnight IEA Executive Director Birol warned that the energy crisis could worsen.  He predicted that “we may not have seen the worst of it yet, this is affecting the entire world”.

Thousands of mourners have lined Tokyo’s streets to pay their respects to former PM Abe who was assassinated last Friday.  Commentators are speculating as to whether his death could allow PM Kishida to move back to a more fiscally prudent set of policies.  There is also speculation as to whether the ruling coalition’s success in the weekend’s upper house elections (in part due a sympathy vote after Abe’s death), could mean Japan is closer to amending its constitution.  Although the constitution was reinterpreted during the Abe years, he never achieved his objective of changing the pacifist constitution, which has been in place since the end of the second world war.   Five Russia navy vessels were reported to have sailed around most of Japan last month and a strengthening in Chinese/Russia military activities has been reported near Japan.