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🔔 There's Another European Crisis Brewing

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The Eurozone's looking dicey (again).

Front month European Gas prices are through the roof, hitting record highs earlier today.

German front month power struck a peak of EUR 375/MWh on Wednesday morning, up 40% on the day and its strongest level since December -Montel

Eurozone inflation printed 5.8%

The inflation rate continues to soar on energy price effects.

With brent oil now above $110 per barrel and natural gas prices soaring as much as 60% this morning as the war in Ukraine continues, further spikes are to be expected in the short-run although base effects for fuel are becoming a substantial drag on the number.

It’s not just energy, food prices are also rising further on the back of the conflict and that adds to worries about elevated inflation for the months ahead. - ING

In the US, wage growth is more or less keeping pace with inflation.

In the EU however, wage growth is waaaay off the pace. Italy's 0.6% wage growth vs the 5.8% EZ inflation rate is pitiful 👇

Chart by @OliverRakau - (red lines/text all my own work 😎)

Can the Eurozone cope with high energy prices without falling into recession?

History suggests not... 👇

Pictet

If energy prices continue to rise, a recession becomes far more likely:

  • Stagnant Wage Growth + High Inflation + Increasing Energy Costs = Consumption & Investment Slow / Recession

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Ah well. Back to the old playbook for the ECB. No rate hikes and infinite QE. A weaker euro is good for exports I guess. C'est La Vie...

Calm down Bernie. Jeez.

However, he does have a point. At a time when energy prices are soaring, what good is a weaker currency to you?

A stronger currency buys you more oil and gas.

Crude oil priced in euros is at record-highs...

Deutsche Bank strategist George Saravelos makes the case for the ECB to break the habit of a lifetime and intervene in the opposite direction, before a weak currency inflicts real damage on the eurozone...

The key details... 👇

There is of course a big difference between what the ECB should, versus will do. But EURUSD depreciation on the back of the Ukraine crisis is now starting to inflict damage on the Eurozone.

The ECB needs to start thinking about ways to stop this.

The euro is becoming increasingly negatively correlated to oil and natural gas prices. The more oil and natural gas push higher, the more the euro drops, pushing commodities priced in euros even higher - a vicious inflationary spiral.

There are of course a number of ways for the ECB to intervene in the market, starting with verbal intervention.

We would note that Governing Council Schnabel last week explicitly talked about the benefits of a stronger exchange rate to push commodity prices back down.

If things get disorderly, coordinated FX intervention by the G7 in a show of unity with Europe should not be ruled out. But ultimately, the most effective way for the ECB to defend the euro is by bringing rates back to positive and enacting a "stability QE" program to defend peripheral spreads at the same time.

This policy mix would be the single most effective "firewall" Europe can erect against the stagflationary risks of a rapidly deteriorating crisis.

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It's a pretty bleak picture he's painting, and in the circumstances it's hard to rule anything out entirely.

The ECB does have form for intervening when absolutely necessary...

 🇪🇺 Talks of ECB intervention in the FX market may sound silly (DB Saravelos), but I wouldn't rule out anything at this point.

The ECB intervened in FX markets in 2000 to stabilise the EUR, and again in 2011 following the earthquake in Japan.https://t.co/lY2jdklbaR pic.twitter.com/RwKrOyoxqb— Frederik Ducrozet (@fwred) March 2, 2022 

And it would be no surprise to see Lagarde wholeheartedly and sternly clarify that the ECB is ABSOLUTELY here to close the spreads (between the borrowing costs of EU member states).

Soon

As for coordinated G7 FX intervention, it would really take something to reach the kind of extremes that would make a modern day Plaza Accord (1985) necessary.

However, it isn't beyond the realms of possibility that the dollar would significantly appreciate in the near future. Especially if the Federal Reserve is forced to keep tightening to bring down inflation at home...

History doesn't always repeat, but it often rhymes 👇

The tight monetary policy of Federal Reserve's Chairman Paul Volcker and the expansionary fiscal policy of President Ronald Reagan's first term in 1981-84 pushed up long-term interest rates and attracted capital inflow, appreciating the dollar.

From 1980 to 1985, the dollar had appreciated by about 50% against the Japanese yen, Deutsche Mark, French franc, and British pound, the currencies of the next four biggest economies at the time.

Over the longer-term, a weaker euro seems inevitable. But don't bank on the ECB giving it up without a fight.

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