Mon, Dec 05, 2022 @ 02:26 GMT
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Weekly Focus – Energy Crunch Worsens

As markets continue to price in higher natural gas and electricity prices for the coming year, the euro area looks increasingly more vulnerable and EUR/USD traded below parity to the lowest level in almost 20 years. The energy crisis also spilled over to other markets. Investors are turning more worried about second round effects on inflation and markets’ inflation expectations ticked higher. Oil markets were also affected, as the incentive to switch energy source has increased and oil traded back above USD100 per barrel. 10-year US treasuries edged back above 3% for the first time in a month driven by expectations that the hiking cycle from the Federal Reserve is far from over. Also Bunds traded higher as markets are now pricing in 200bps hikes from the ECB as opposed to 130bps two weeks ago.

Higher yields were hard on equity markets, where stagflation fears are dominating, even if China’s State Council did step in with a 1 trillion yuan spending package as China is struggling with repeated COVID lockdowns, waning global demand and a vulnerable property market.

PMIs in the euro area were slightly less gloomy than expected, but indicates a slowdown as inflation is digging deep into consumer pockets. In the US, PMIs indicate the service sector is slowing faster than expected. On a positive note, businesses’ selling prices are increasing at a softer pace. That said, forward prices in energy markets indicate large heating bills ahead in Europe and we see no signs that wages will cushion the blow to purchasing power much. Euro area negotiated wage growth dropped back to 2.1% in Q2 from 2.8% in Q1, as one-off payments dropped out of the figures. The underlying trend is a moderate increase in wage growth.

With the threat of energy rationing and production cuts later this year still looming, the near-term outlook for the euro area economy remains challenging. Our recession model indicators for the US and Eurozone show that a recession is certainly nearing, especially in the euro area, but the labour markets and investment cycles are still holding up relatively well on both sides of the Atlantic giving some cushion for the time being.

Next week, the most important data out of the euro area will be the inflation figures. We look for a marginal slowdown in core inflation to 3.9%, but a further increase in headline inflation to 9.2% on the back of higher energy prices. In contrast to the US, we have not seen the inflation peak in the euro area yet and we look for further increases to double digit rates in Q4, leaving the pressure on for more ECB hikes.

In the US, markets will be looking out for signs of a looser labour market, as we get both job openings and a jobs report. Consensus is for another 290,000 employed but markets will be looking at the full picture of indicators to decide whether the pricing of Fed is fair. In China, we look for weaker manufacturing PMIs on the back of weaker export orders and a continued weak property market.

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Danske Bank
Danske Bank
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