See the latest Australian dollar analysis here:
Nordea with the note:
A couple of weeks ago we moaned about not being able to focus on proper macro strategy due to a cocktail of bodega-virology and cynical political analysis being more important than economic fundamentals – and then an energy crisis emerges. We have talked about the risk of a stagflationary development due to global (or maybe in particular European) energy politics for a while, but it’s as if nobody has cared until the actual practical problem has now materialised. No one is talking about Evergrande anymore after surging gas and coal prices have taken the limelight; therefore we decided to take a deep dive into global inventory levels during the week. We were frankly shocked by the findings as stocks are low no matter where you look (maybe except for the US) heading into the winter, which means that we may not have seen the worst of this energy crunch yet.
German inventories of natural gas are scarily low ahead of the heating season where we usually rely on the inventories. Gazprom’s major storage sites in Germany (Katharina, Jemgum, Redhen and Etzel) are shockingly low already, which means that inventories will run frighteningly close to zero by mid-March 2022 if the usual seasonal patterns unfold over the winter.
There are 2327 words left in this subscriber-only article.
Get your first month for $1
The current 16900 MCM/D inventory in Gazprom’s German facilities is barely enough to survive the winter, as the inventories usually drop by 17500-20000 MCM/D from late October to mid-March. This is too much of a knife-edge situation to be truly comfortable with. Remember that natural gas still makes up around 25% of the total energy consumption in Europe. We’re counting on you Russia.
Chart 1. Gazprom storages in Germany are running way below historical averages … AAAAAAH!
So how did we end up in this situation? Germany’s rapid move away from nuclear electricity capacity probably plays a substantial role, as the change in input mix since the launch of the so-called Energiewende in late 2010 has increased the weather dependency of the European electricity grid. And the more weather-dependent an electricity infrastructure that you create, the bigger the need for a double infrastructure in case of emergency.
Windfarms have produced 30-40% less electricity year to date compared to a normal year, which paired with a structurally distressed supply chain has chased energy input prices up into the stratosphere with continued bizarre daily price increases in natural gas, coal and partly oil currently. This wouldn’t have been an issue unless the delivery boy was named Vladimir.
Russia is currently effectively in charge of electricity prices in big parts of Europe, which is an issue that the EU will have to address immediately. The most likely short-term solution is that southern European politicians decide to “foot the bill” via the public budget, while consumers will be asked to cave in across northern Europe.
This is the first huge test of the green agenda, as this energy price surge will hit practically all average households quite hard. Will they accept being run over by elites pushing through price increases for the sake of the climate? This could turn into a hot potato in for example the French and/or other upcoming elections in Europe.
Chart 2. Putin is currently in charge of the electricity bill in Europe
The energy crisis also serves as a friendly reminder of why we remain long USD into the year-end with a high conviction. US growth figures are likely to be less affected by the energy scarcity in 2022, as for example gas prices in the US have not yet surged to the extent seen in Europe.
Shale producers (those still up and running) may also capitalise on the current energy squeeze, which leads us to a bottom-line scenario of Europe and China being more vulnerable to the current developments. This is also our conclusion when looking at the energy consumption price index in each of the three areas. Stay long USD (versus both CNY and EUR).
Chart 3. The energy consumption index is developing more sharply in China and Europe than in the US
The big question is how central banks are going to react to the ongoing energy-flationary spike as markets seem to fear that they will have to respond to the mounting cost pressures via a tighter monetary policy, even if they dislike doing it. The Bank of England probably ignited this fear a few weeks ago after sending a moderately hawkish signal due to price increases amid a bizarre supply-side disaster in the making in the UK. Also several CEE central banks (Czech Republic, Poland etc) have added to the trend by raising interest rates in response to energy-fuelled inflation spikes.
The Fed might add to that narrative, if the non-farm-payrolls report is “decent enough” this afternoon (this Week Ahead was edited Friday morning CET), which goes to show how monocausal NFP watching by the Fed is not a good idea. Powell sounded taper-trigger ready already at the August meeting but ended up communicating that a decent job report in September would be enough for him to initiate tapering at the November meeting. Meanwhile the “odd-dove-out” in Frankfurt is mulling a new QE-program to replace the PEPP. May we suggest PCPP – Permanent crisis purchase program?
Since the August meeting, personal account dealing rules within the Fed have taken centre stage and both Kaplan and Rosengren have stepped down consequently (Rosengren citing bad health). Powell also traded actively during the corona crisis, and it looks increasingly likely that the Democrats will use that as an excuse to throw him under the bus and pick another chair(wo)man.
Powell has called for an ethics review of the trading rules within the Fed, but after all it’s not every day that Elizabeth Warren calls a Fed member a “dangerous man”. The implied probability of Powell getting re-confirmed as the Fed chair by the Senate has dropped in prediction markets, but he remains the firm favourite (probability around 70%), while Lael Brainard has gained pace as a potential replacement. From being indisputable, we now wouldn’t rule out that Powell is sacrificed on the alter of wokeism as it would suit the agenda of left-wing Democrats better to have another candidate in charge of the FOMC.
Chart 4. Powell is not a done deal as Fed chair going forward
We expect Powell to hawk things up in either case. Should he be re-appointed (still our clear base case), then he will be able to scale down on the woke rhetoric that has been a requirement in the run-up to the re-appointment. Should he be ousted, then he might argue that he sees a tapering launch as a necessity before Brainard or Bostic takes over the reins. We have seen such directionally guided handovers of the Fed chairman seat before, most recently when Yellen left Powell a clearly communicated hiking cycle to tap into. Powell may hence end up leading his successor’s hand, no matter whether the Democrats want it or not. Powell is a hawk by nature, not a wokeism-friendly dove. Just remember his voting records back in 2013/2014 when he was one of the main advocates of tapering.
It’s a weird cocktail trading-wise as the energy squeeze suggests that you should bet on steeper curves and even higher inflation premiums, while the November tapering basically pulls in the other direction. Maybe the best bet is just to stay long USD, which is still a high conviction bet of ours, while betting on even more bizarre inflation prints than those already priced into the front end. This short-term squeeze ain’t over yet.
Ultimately the energy crunch is likely to add to the cyclical downturn that is already on the cards, which means that you should position for anti-cyclical asset allocation moves, but timing is obviously of the essence, and it is currently extremely tricky to pinpoint when to start betting against the cycle. We’re closing in on such timing, and while it might not be yet, it may still be worthwhile slowly but surely starting to prepare for it in a bigger portfolio.
Chart 5. Tapering usually leads to a flatter USD curve (between 5s30s) and a stronger USD
The cycle is clearly going down during 2022 according to our models, while the big question is inflation, which is likely to stay elevated even during a downturn of the manufacturing cycle. How will the Fed put look like if the manufacturing cycle falters, with the median CPI prints at 3.5-4%? Tricky one for the Fed to manoeuvre.
Chart 6. Time to switch from cyclicals to defensives according to our G3 credit impulse indicator
And Morgan Stanley:
EM weakness has accelerated thanks to the Fed, China and inflation risks. We don’t think it’s over just yet and stay short EMFX and favour IG over HY in credit. USD strength and UST losses create a challenging backdrop.
FX&EM Strategy: The US dollar has broken higher and made progress towards our 1.14 EUR/USD target, equivalent to around 96 on the DXY. We thus expect some more USD gains, taking the GBI-EM index lower in the final months of the year. Yet, we have seen a reasonable EM sell-off in the past few months and, while we see a little bit further to go, we don’t see a big reason to be extending targets either.
SovereignCreditStrategy: With EM BIG-D spreads moving beyond our 360bp target, the larger moves wider are likely behind us. However, with upwards pressure on US real yields and EM FX but downwards risks to the growth outlook, it’s too soon to fully buy into HY, particularly given that fund positioning is still heavily OW HY. Also,HY valuations are only slightly cheap, including the average cash price of single B credits still trading at par.
The Quant Angle: Our directional models remain firmly long USD while the cross-sectional portfolios are short CNY proxies such as TWD, KRW and CLP. The model is short EUR in G10. This comes against oil currencies as preferred longs with NOK, RUB and COP as top allocations.
My own view remains there is scope for another bigger EM washout as China overshoots to the downside, commodities crash and stocks correct on the Fed taper.
Anyways, short AUD remains the play, mitigated in the short-erm by the energy buble.