Weekly View - Energy Alert
Last week markets were focused on the potential for recession, be it as a consequence of central bank wars against inflation or the current global energy dynamics, with Russia’s finger on Europe’s gas supply pulse. Russia reduced gas flows to Germany, serving as an all too present reminder of how commodities can be weaponised between nations. Germany was forced to restart its coal plants as a result in order to save gas for this coming winter. Higher European gas prices will add further price pressure both directly and indirectly, through higher prices for fertilisers for agriculture and food. President Putin also referenced a new basket-based reserve currency under development by the BRICS group of emerging-market (EM) countries as an alternative to the US dollar. We are positive on EM currencies.
European purchasing manager indexes (PMI) for June were weaker than expected. The breakdown by sector showed that manufacturing output declined into contraction territory. Given the sharp fall in the new orders index, the decline in manufacturing is unlikely to stop in the coming months. Meanwhile, higher interest rates continue to affect the US housing market. Existing home sales in May fell for the fourth consecutive month, with sales having fallen at an annualised rate of 33% in the three months to May. Home sales are tracking the steep decline in mortgage applications, which have fallen for six straight months and have a good deal further to fall.
Bad news for the economy is good news for markets as it curbs sovereign yields. The US 10-year Treasury yield declined to 3.13% and the German Bund’s came down to 1.44% last week. We are neutral on US Treasuries. Commodity prices reacted negatively to the weakening economic numbers, with industrial metals and oil falling by 7% and 8.5%, respectively. Equity markets rebounded on the back of lower yields and investor optimism that central bankers will pivot monetary policy to avoid a recession after Friday’s University of Michigan Inflation Expectation print showed slight cooling in May. All eyes will shortly be on corporate earnings as investors try to determine whether the economic slowdown will translate into an earnings recession. The number of companies providing guidance (100 constituents of the S&P 500) is back to normal. That said, guidance is a bit worse than average, with 70%/30% negative/positive. The second quarter of 2022 is expected to be the worst one in terms of year-on-year earnings growth, given it is the quarter with the strongest base effect. This week G7 leaders are in Germany to discuss potential price caps on Russian oil exports in their first summit since Russia’s invasion of Ukraine.