Market moves have been reasonably subdued overnight, with the US market closed for Labor Day. The focus has been on the European energy crisis. European gas futures increased around 15% while the EUR broke below 0.99 for the first time in 20 years, before recovering. Likewise, the GBP broke below 1.15 yesterday, nearing a 37-year low, ahead of confirmation Liz Truss would become the new UK PM. European rates are modestly higher overnight while the US 10-year bond future is around 5bps higher, reversing some of its post-payrolls move lower. The NZD has had a quiet night, hovering just below the 0.61 mark.
Dutch gas futures, the European benchmark, have increased around 15% overnight (having been more than 30% higher at one stage), following Friday night’s news that Gazprom was indefinitely suspending gas flows to Europe through the Nord Stream 1 pipeline. European wholesale gas prices are trading around 30% below the levels reached just over a week ago but they are still almost double what they were at the end of May. The fear is that there might be energy shortages in Europe if the winter weather is colder than normal, in the absence of measures to cut demand. At the extreme, this could involve power rationing, setting the stage for a major recession in the region.
Putin’s spokesperson said there would be no resumption in gas supply to Europe until sanctions are lifted, implying (to no one’s surprise) that the real motivation for the suspension of gas flows was to inflict punishment on Europe, not technical faults with the turbine. The focus now turns to the meeting of European energy ministers on Friday for the EU response to the crisis. A series of emergency measures are reportedly on the table, ranging from measures to cut demand to caps on energy prices and a windfall tax on energy producers. French President Macron voiced his support for a windfall tax last night.
The broader asset market reaction has been reasonably measured, suggesting either investors had already attached a significant probability to Putin cutting off gas supplies at some stage or that market participants think the EU policy response will help mitigate the impact. The EUR broke below 0.99 overnight, the first time in 20 years, amidst the initial surge in gas prices, but it has since recovered to around 0.9925, now down only 0.25% on the day (most of the fall in the EUR in response to the news that gas flows would be suspended came on Friday night – it was trading around 1.0030 before Gazprom’s announcement). Likewise, European equities opened sharply lower, but there has been a notable recovery over the trading session, the EuroStoxx 600 index ending down only 0.6%.
The GBP fell below 1.15 yesterday, nearing its lowest level since 1985, although it too has recovered overnight, now back above that level. Sentiment towards the GBP remains very negative given the stagflationary shock of higher gas prices and concerns around new UK PM Liz Truss’ proposed policy mix. Truss has proposed a major fiscal loosening including, among other measures, to reverse the recent increase to national insurance and cancel the planned increase to the corporate tax. The policy mix is contentious because it risks further inflaming inflation at a time the Bank of England is already having to battle with CPI inflation in the double digits.
The UK papers have also reported that Truss is considering an energy price freeze to protect households from skyrocketing energy bills, although the exact terms (e.g. the price level and duration of the scheme and whether it applies to all households or just lower income ones) are not yet decided. Truss is reportedly due to make an announcement on the energy crisis on Thursday night. The FT reported that Truss’s total policy package, including support for energy consumers, would be close to £100b (~4.5%/GDP), more than the cost of the UK’s job supporting furlough scheme during Covid. The likely increase to government borrowing will come at a time when the Bank of England is engaged in quantitative tightening, putting upward pressure on UK bond rates. The UK 2-year rate was 10bps higher overnight while the 10-year rate was 2bps higher, just below 3%.
The US bond market has been closed for Labor Day, but futures markets point to around a 5bps increase in the 10-year rate, partially reversing the move seen after nonfarm payrolls.
In other new, the Chinese city of Guiyang, with a population of around 6 million people, will lock down large parts of the city for the next four days, the latest centre to impose restrictions after the emergence of more Covid cases. Chengdu and large parts of Shenzhen are currently locked down while the authorities undertake mass testing.
The CNY remains under downward pressure amidst continued concerns around the Chinese growth outlook and broader USD strength. USD/CNY closed at a fresh 2-year high yesterday, around 6.9340. As USD/CNY approaches the pivotal 7.0 level the authorities continue to lean against the pace of yuan depreciation. Overnight, the PBOC announced a reduction to the amount of foreign currency deposits that banks need to hold at reserves, a measure intended support the yuan. The reduction to the foreign exchange reserve ratio, from 8% to 6%, was the second such move in four months. The PBOC also set the daily yuan fix at a stronger-than-expected level for the ninth day in a row yesterday, signalling its discomfort with the pace of CNY depreciation.
It’s been a quieter night for the NZD and AUD given the US Labor Day holiday, the NZD drifting back below 0.61 and the AUD easing back to 0.68, both currencies down around 0.2% so far this week.
OPEC+ announced a small reduction to oil supply at its meeting overnight, a move foreshadowed by recent comments from Saudi Arabia but not expected by most analysts. Analysts see the 100,000 barrel per day production cut as largely a symbolic move, warning that the cartel is prepared to respond if prices fall much further. Oil prices have pushed higher overnight, Brent crude oil increasing almost 3% to almost $96.
It was a quieter session in the domestic rates market yesterday, a welcome break from recent extremely high levels of volatility. Swap rates from 2 to 10-year maturities ended less than 1bp changed from Friday night’s closing levels, despite the chunky falls in US rates after nonfarm payrolls. Yesterday saw an upside surprise to building work data, which points to upside risks to our 1.5% q/q Q2 GDP estimate.
The RBA meets this afternoon, with all but two economists surveyed by Bloomberg expecting a 50bps hike in the cash rate and markets 85% priced for such an outcome. The focus will be on the RBA’s characterisation of the policy outlook, with market pricing split between 25bps and 50bps for the following two meetings. Governor Lowe will also be speaking later this week. The market focus tonight will be on the ISM Services index, with consensus market is looking for a slight fall, to what would be a still healthy 55.4. The shockingly weak Markit Services PMI for August (44.1) probably warns of downside risk to that consensus estimate.
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