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BFM Market Watch: King Dollar Deposed For Now

This podcast was first and originally published on https://www.bfm.my/podcast/morning-run/market-watch/bank-of-japan-monetary-policy-revisal-japanese-yen-us-fed-rates-markets-outlook

The CEO of Compete Intelligence, Tony Nash, was interviewed on BFM to discuss the current state of the US markets.

The S&P fell 1.6%, the worst decline in a month, and the tech-heavy Nasdaq snapped a seven-day rally, reversing gains of more than 1%. Nash suggests that this may be due to bad economic data, specifically PPI and retail sales falling, but also notes that consumer is still strong. Nash explains that the US economy is built on services, so people may be trying to confirm their downward bias in things, and when bad news is reported, a sell-off day occurs. Nash also mentions that if PPI falls, that should mean inflation is slowing, which should mean the Fed would ease a little and slow down on rate rises.

He also mentions that markets may be spooked by all the announcements regarding job cuts, such as Microsoft announcing they plan to cut 10,000 jobs and Bank of America telling their executives to pause hiring. Nash suggests that these job cuts are small in terms of the gap that we see in the US workforce, which is still missing millions of jobs in terms of the openings versus the available people.

Nash also mentions the yen tumbled yesterday after the BOJ went against market expectations by keeping its yield curve tolerance ban unchanged. He suggests that the BOJ is managing the yield curve to suppress borrowing costs and wants to keep it below 0.5%. Nash also mentions that Japan’s central bank is getting pressure from other central banks to keep their rates low, this means that if Japan lets their rates rise, then that would have a knock-on effect around the world and cause a repricing of government debt all around the world.

Nash concludes by saying that he expects a weaker yen, but doesn’t think we would necessarily hit those lows.

Transcript

BFM

This is a podcast from BFM 89.9, The Business Station. BFM 89.9. It’s 7:06, Thursday, the 19 January, and you’re listening to the Morning Run with Chong Tjen San and I’m Wong Shou Ning. And earlier on, we did ask our listeners how traffic is like and Roberto said traffic today really smooth and super low compared to just yesterday. He loves Chinese New Year in KL. And so do we. I just love Chinese New York because I like the feasting and I like the ang bao collecting.

BFM

I get the hint.

BFM

Yes, we’re all looking at you, Tjen San. But in 30 minutes, we will be speaking to Angela Hahn of Bloomberg Intelligence on the impact of China’s reopening to Markhouse gaming and hospitality sector. But in the meantime, let’s recap how global markets closed yesterday.

BFM

After a good run, all key US. Markets ended down yesterday. The Dow was down 1.8%, S&P 500 down 1.6%. The Nasdaq was down 1.2%. In terms of Asian markets, the Nikkei was up by 2.5%, Hang Seng up by 0.5%. The Shanghai Composite Index, it was unchanged, the Straits Times Index, it was up by 0.3%, and the FBMKLCI it was down by 0.3%.

CI Futures has S&P500, Nikkei, Nasdaq, Hang Seng, and nearly a thousand other assets across equity indices, currencies, and commodities. Subscription starts at $99/mo with a monthly commitment. Learn more here.

BFM

Why are we always again and again there’s a trend here for sure. But to tell us where international markets are heading, we have on the line with us Tony Nash, CEO of Compete Intelligence. Good morning, Tony. Help us understand what’s happening in US markets. Because the S&P fell 1.6% is the worst decline in a month. Tech heavy Nasdaq snapped a seven-day rally, reversing gains of more than 1%. Is this just really due to bad economic data?

Tony

Yeah, we saw PPI and retail sales fall today. The weird part is consumer is still strong. The US economy is really built on services, so I think people are trying to confirm their downward bias in things. And whenever we see bad news, we see a sell off day. So I’m not necessarily sure I would read that much into it, aside from just there was really nothing else going on. So people saw some bad PPI news and they were negative. So if we see downward PPI, that should mean inflation is slowing, which should mean the Fed would ease a little. Not ease, but would slow down on rate rises a bit. So that should have been positive news for markets. So it’s just kind of a weird read of some of that data.

BFM

Do you think markets are also spooked by all these announcements with regards to job cuts? Because Microsoft says they plan to cut 10,000 jobs. Amazon of course, made announcements last week, and even Bank of America is it telling their executives to pause hiring. Not great for the mood on Wall Street?

Tony

Well, maybe, but I think those job cuts are actually kind of small in terms of the gap that we see. So the US is still missing millions of jobs in terms of the openings versus the available people so I think there’s something like 7 million jobs open. We also had a million people post COVID not come back to work. So we have a gap in the workforce, just a status quo workforce of a million people, but we have something like 7 million open positions. So when Microsoft lays off 10,000 people or Goldman lays off 4000 people, sure, it’s tragic. It’s definitely tragic for those individuals. But in terms of the overall health of the economy, it really doesn’t make that much of a difference.

BFM

And Tony, the yen tumbled yesterday after the BOJ went against market expectations by keeping its yield curve tolerance ban unchanged. What possible reasons would the central bank have for keeping this status quo?

Tony

Yes, so the BOJ is managing the yield curve to suppress borrowing costs and they want to keep it below kind of 0.5%. There have been some hedge funds and some big investors who’ve been betting that they would tighten it. And the BOJ is just bigger. I mean, when they came back and they said, we’re going to hold the line at 0.5, they spent about $100 billion so far this month to defend that and they have plenty of resources to hold that. So the release issue is this is if Japan lets their interest rates rise, then Japanese, say, banks and pension funds and other investors would consider selling debt from other parts in the world and buying Japanese debt. Okay, so if Japan lets their rates rise, then that would have a knock on effect around the world and that would cause a repricing of government debt all around the world. So it’s not just the BOJ wanting to keep this for Japanese domestic reasons. They’re getting pressure from other central banks to keep their rates low.

BFM

Okay, Tony, but what does this then all mean for the yen? I mean, at its worst point, the yen was trading 150 against the US dollar. Today it’s 128. That’s a very wide range in just a few months. So what are your expectations?

Tony

It is yeah, certainly I would look for a weaker yen. I don’t know that we would necessarily hit those lows. But the BOJ has made their stance clear. The BOJ has a new head coming in in a few months. I would say they’re unlikely to dramatically change policy with a new head because they don’t want to make people nervous. So I think they’re going to aggressively defend the status quo. So I don’t necessarily think you see a yen appreciating dramatically from here. I think the bias is really toward the downside.

BFM

Okay, staying on the topic of currencies then, what’s your view on US dollar? We’re just looking at the Bloomberg Dollar Spot Index this morning. It’s already down 1.5% on a year to date basis. The era of King dollar, is it over?

Tony

Well, I think not necessarily. If you’re looking at the DXY, it’s really heavy on the euro. And so we’ve seen Europe do better than many people thought through the winter because we haven’t had a cold winter there and energy prices haven’t bitten as hard as many people thought they would. So I think Europe is doing better and the Euro is doing better than many people thought. And everything in Currencies is relative. China is opening, although it’s gradually. China is opening. And so that’s good for CNY. Again, in a relative basis, I think there is downward pressure on the dollar, but I don’t necessarily think we’re over on that. I don’t think we’re heading straight down to, say, 95. I think we’re going to see some back and forth over the next couple of months as we figure out what the forward trajectory of the dollar is. And a lot of that really has to do with what direction will the Fed take in terms of their rate hikes and their quantitative tightening. And it has to do with treasury activity from the US. Treasury. How will they spend, what will they do, how will they fund the US government?

BFM

Tony, some analysts are saying that without a recovery in the Chinese economy, a global recession is all but assured. But what are your thoughts on this?

Tony

I don’t necessarily think that’s the case. I think China will do okay this year, and I think regardless, Europe will likely dip into recession this year, although fairly moderate. In the US, you see a very strong employment environment. And so employment is one of the key considerations for recession. So I don’t believe the US. Will dip into recession really on the back of employment news more than anything else. And so once we see some of these layoffs with larger companies and we get through this as, say, equity valuations stabilize, I think we’ll start to see a renormalization in the US economy as the Fed kind of takes the foot off the brake of the US economy. Of course, the Fed will continue to raise rates, but they’ll do it at a much slower pace, and that will make people much more comfortable in doing things like investing capital and so on and so forth, that will help the US to grow.

BFM

All right, thank you very much for your time. That was Tony Nash, CEO of Complete Intelligence, giving us his outlook for the world economies and also markets in the coming weeks. I think very much the question everyone has on their mind is Fed rates. What is the terminal rate? Will they basically raise rates too much and then cause the US. Tip into a recession? But I see increasingly our guests, our commentators sounding a little bit less pessimistic, hinting that perhaps we’re going to have a soft landing rather than a hard landing.

BFM

Yeah, I think it’s really on the back of the really still strong employment in the US. I mean, he did mention there’s still 7 million jobs available in the US. And there are one million people post COVID that didn’t come back to work. And I think that really is his key point, that the US may not slip into recession, but it looks like EU will and China, it looks like they are really on track to a better recovery this year. I’ve seen some economists say that GDP growth could be like five to 6% as well.

BFM

I see that consensus figure that range is around there for China’s GDP for 2023. Now, turning our attention to corporate that released results they reported, which is Alcoa excuse me, which is aluminium company. They reported fourth quarter results earlier today, which saw losses narrow to $374,000,000. Loss per share as a result was $2.12. The loss included a 270 million charge related to tax expense. Revenue did decline 20% to $2.66 billion.

BFM

And Alcoa attributed the decline in revenue to lower prices for both Alumina and aluminium. Additionally, Alcoa will see some executive leadership changes effective February 1, including CFO William Oplinger reassignment to chief operations officer, in addition to his executive vice president role.

BFM

Okay, the street doesn’t really like this stock when you look at Bloomberg. Five buys, only seven holes, no sells. Consensus target price for the stock, $52.18. During regular market hours, the stock was already down one dollars. And now I think we need to talk about one of the world’s biggest companies, Apple. They are expanding their smart home lineup, taking on Amazon and Google. Are you surprised by this move?

BFM

Jensen not surprised at all. I think Apple is really the leader in terms of innovation, and we’ve seen it over the years, so no surprises there. So I think they’re launching some new devices. There’s a smart display tablet, there’s a HomePod. There’s a TV box and a MacBook and Mac mini using their cutting edge new processor, which is the M Two chip.

BFM

Are you going to buy any of these gadgets? You don’t even use an Apple phone. You haven’t joined a cult. You’re about the only one on the morning run. You and Philip sees that hanging on.

BFM

The iPad at home, but they’re quite old.

BFM

Okay, but will this make a dent to Apple’s earnings? Perhaps. I think they are trying to diversify their product range, because the iPhone, I think, hasn’t done as well as expected. If you look at Apple or Cost, still a darling on Wall Street. 36 buys, eight holes, two sells. Consensus target price for this to $169.24. At regular market hours, it was down seventy three cents to one hundred and thirty five dollars and twenty one cents. I, for one, will be curious as to what these products will be or how they’ll fare. Up next, of course, we’ll cover the top stories in the newspapers and portal. Stay tuned for that. BFM 89.9 you have been listening to a podcast from BFM 89.9, the business station. For more stories of the same kind, download the BFM app.

Categories
Week Ahead

The Week Ahead – 15 Aug 2022: Europe drought: Cost, energy & industry impact

Learn more about CI Futures here: http://completeintel.com/2022Promo

In this episode, we talked about the European drought — and looked at the cost, energy impacts, and industry impacts. We also talked about coal and discussed more broadly energy. But more specifically coal, and what will be some of the issues around it. How will the coal issues impact refineries and other downstream activities? Finally, we looked at inflation. It’s been covered to death last week — CPI PPI — but we also put a few words in on it.

Key themes
1. Europe drought: Cost, energy & industry impact
2. Coal & energy
3. Inflation
4. What’s ahead for next week?

—————————————————————-

This is the 30th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.

Follow The Week Ahead panel on Twitter:

Tony: https://twitter.com/TonyNashNerd
Albert: https://twitter.com/amlivemon/
Tracy: https://twitter.com/chigrl

Listen to this episode on Spotify:

Time Stamps

0:00 Start
0:49 Key themes for this Week Ahead
2:16 Europe drought: containers on the Rhine
4:22 How hot is Europe compared to other places?
5:25 How is France doing?
6:02 Europe’s embargo of Russian coal – will it make things worse?
7:48 The beneficiaries of Europe’s Russian coal embargo
9:32 Where’s most of the coal coming from?
10:00 Rhine River and how it affects coal and crude transport
13:00 Is there a silver lining in what’s happening in Europe?
14:16 How will the happenings in Europe impact politics in the region?
15:36 How you should be playing European equities?
16:40 Have we hit the peak inflation?
20:22 Will there be a Feb pivot?
21:17 What’s for the week ahead? Listen to the podcast version on

Transcript

Hi everyone. Thanks for joining us for The Week Ahead. I’m Tony Nash with Complete Intelligence. We’re joined by Albert Marko and Tracy Shuchart as usual. And Sam is out this week and he’s fishing, so I hope he sends us some when he’s back. Some good fish pictures, though. Great pictures from Maine or Vermont or wherever he is. So it’s just beautiful up there.

So this week we’ve got a couple of things on top. First, we’re talking about the European drought. We’re looking at the cost, we’re looking at the energy impacts, industry impacts. Then we’re looking at coal more broadly, energy, but specifically coal, and what will some of the coal issues, how will that impact refinery and other downstream activities?

Finally, we’re looking at inflation. It’s been covered to death this week, CPI PPI, but we’re going to kind of put a few words in on it and then we’ll look at the week ahead.

So before we get started, please like this video, please subscribe to this video. Please give us your comments. We always do come in. We always do respond to comments, even if they’re negative.

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All right, so thanks very much for that. Guys, let’s dive into this for Europe. I want to look at there have been a couple of things out, stories out today about containers on the Rhine not being able to get. There’s a tweet from Bloomberg Energy that we’re showing where container companies can’t get containers up the Rhine and obviously the heat and the drought and there are a number of issues for Europe and Germany specifically.

So Albert, can you kind of go into that? And we’re going to switch to the water levels on the Rhine as well so you can see the red line is well below year to date for water levels on the Rhine.

So Albert, can you kind of help us understand what’s going on there and what the impacts are going to be?

AM: Yeah, I’ll circle back to Germany, but there are other countries that are having similar problems at the moment. You have the Italian. Italy’s pool river completely dried up. Unbelievable. The UK suffering the same effects. Heat waves are hitting France. And this is really bad timing, especially when it comes to inflation, because the commodities and energy prices are skyrocketing.

Now, they have problems for the irrigation of the crops. They have transportation down certain riverways. So the costs are just set to inflate even further from this point on.

Germany, being pretty much the economic engine of Europe right now, is just absolutely taking it on the chin month after month. And this is certainly something that they don’t really need to be happening at the moment.

The Rhine River, like you’re saying, has big effects for multiple industries, specifically energy. They just can’t get things up and down the river at the moment. And the stuff that they can get down the river, the shipping costs have gone. I don’t even know what the rate is the last time I saw this, two or three times the normal rate.

So at this point, it’s like the Europeans, they need a winter where they have a lot of snow or a lot of rain. Otherwise, they’re facing a financial crisis coming.

TN: So let me ask you this. This is going to sound pretty ignorant, but I live in Texas. It’s really hot. Florida, it’s kind of warm, a little bit beautiful. Great place to move if you’re from California. But it’s easy for us to say, “gosh, we deal with heat all the time, it’s not a big deal.” But Europe is a lot hotter than it usually is, right? So how much hotter? Celsius or? 

AM: I wouldn’t say that. Maybe the timing of the heat waves is really bad with the droughts. That’s the problem. Because it’s not exponentially hotter than it was previous summers, but it’s just the timing of it is really bad and there’s been no rainfall. Europe has always had a problem with fresh water supply, and that’s why the United States has been blessed that we have ample fresh water.

Forget about the lake meat stuff that you hear right now. I’m talking about in the farm, the Midwest, where all the farms and all the industry is ample fresh water. And Europe doesn’t have that and they are suffering for it right now.

TN: Now, the key crop… So we’ve talked about energy before and you’ve said France, they’ve kind of got their act together and they don’t have to worry like Germany or in Italy does. How is France doing compared to the other places? I’m sure they’re suffering, but are they a little bit better put together? 

AM: They are a little bit better put together. They have ample food supply that sustains their nation. I think they sold 40% of the wheat crop to China, which I think is probably going to hurt them later on in the year as the job persists. But for France right now, they’re actually sitting far better than Germany is. 

TN: Okay, great. So let’s dig down a little bit more on energy. Tracy, you mentioned before we got on that Europe just embargoed Russian coal, right? With all of the issues and the industry issues in Germany, how much worse does that embargo make things? Before we get into coal prices and all that stuff. How much worse does that make things, the embargo on Russian coal?

TS: Well, it’s just another example of self harm, right. Because we’re already seeing… Russia is already prepared for this. We’ve already seen them sell oil to China, and India makes up for those barrels that are not making it to the west. Right.

And so they’ve already been doing that with coal. Russia has actually become India’s third largest supplier within the last couple of months. And to avoid Western sanctions, they’re also paying in yuan and the Hong Kong dollar. And that’s not to say that the US dollar, they’re trading dollars for those currencies to avoid Western sanctions. So it’s not that they’re not using dollars anymore, but it is that they figured out a clever way to get around sanctions. 

TN: Just circumconvention, right? 

TS: Right. I think that just like oil, where everybody expected three to 4 million barrels to be taken off the market immediately, we never saw this come to fruition because it was such heavily discounted. Those barrels found our way to market anyway, and so is Russian coal, to be honest. So really this hurts Germany more than anything.

That said, the flip side of that is that the beneficiaries of that policy are going to be Australia, United States, Colombia and South Africa.

TN: Okay. So if we look at Australia, just to kind of focus in on there, China barred Australian coal about two years ago, a year and a half ago, something like that? So is there ample supply in Australia to support Europe? And is that new? Have they already been redirecting things to Europe?

TS: I mean, they’ve already been redirecting things everywhere else because demand has suddenly gone up. Right. And not globally. So what we’re seeing, if we look at the benchmark Australian price, which is Newcastle Coal, their prices are about 400 AUD, which is about $284. 

If we look at what current spot prices are going for in the United States, particularly on the East Coast where shipping is a lot less, we can see that those are significantly lower. So that does bode well for coal companies on the East Coast with access to ports, closer access to ports, rather than coming, say, from the Midwest or the West Coast.

TN: So we’ve got the weekly coal price commodity spot prices for us up right now. So the highest there is 186 for Illinois Basin coal. Right. So where is most of that coal coming from? Is it Appalachia? Is it Joe Manchin territory?

TS: You’re going to want to look at Appalachia. Okay. They’re closest to the East Coast, which means your shipping costs significantly go down because you don’t have to ship it across the country first. Clean coal. Yes.

TN: So that does bode well for the United States, just because it’s significantly lower. But I kind of wanted to go back and in the same vein, if we go back to the Rhine River. The fact is that because water levels are so low, they’re about 1.5 meters deep right now. That will sit around 1.2 meters deep. It sits in about 30cm leave room. At the lowest levels right now, where there’s nobody traveling, obviously, they’re about 42cm. Actually, the lowest was in the lowest in the last century was in 2018, where they were about 25cm.

But what’s happening is because, what’s happening with the energy industry in general, because we’re talking there’s a lot of oil products sent down that river as well as coal, is that what these vessels are having to do is they’re having the third with what they’re normally carrying.

TN: So. If you had a vessel that went down and you’re paying X amount of dollars, now you have three vessels going down because you have to split that into a third because those water levels are so low. There’s more demand, there’s higher shipping costs, lower capacity. So those shipping costs are times, what, five or something per unit per ton.

TS: Or are absolutely ridiculous. And then when we talk about like low river levels, they typically impact regional, downstream, refined products. Right. Rather than upstream. So this is going to have a major impact, particularly in Switzerland and Germany again. So this is going to increase the cost of their refined product, particularly diesel, which there’s already a diesel shortage. So I expect that situation to get ten times worse as well as coal and other commodities that are sent out the river.

TN: Okay, so just to shift a little bit downstream. So if you talk about refined products and then we go a step further to say, plastics and that sort of thing. And we look at say, the electronics industry in Germany. We look at automotive industry in Germany. So do we expect a major impact on those industries as well? And at what pace will that happen? Will that be three months? Will that be nine months?

TS: Oh, absolutely. I think that’s going to have a major impact, especially because we’re already looking at those industries, looking to a lot of the manufacturing industry in particular are looking to go from gas to oil switching or gas to diesel switching. 

So if diesel becomes a problem, right. And oil becomes a problem coming down the river, that’s going to make that situation entirely worse. So we’re looking at this situation, I would say three to six months, much sooner than later for certain, especially as we head into the winter.

TN: Oh yeah. So it sounds to me we know that Europe has inflation problems. Right. We know that Europe has energy problems with the river issues and the drought issues. They now have crop problems and they have supply chain problems and they have, say, secondary impacts of, say,  refining secondary, tertiary impacts of refining issues. Right?

So I’m not asking this to be funny, like is there good news out of Europe? Or is there a bright spot in Europe right now? 

AM: No, there really isn’t. There really isn’t. Everything coming out of Europe right now is negative. The ECB came out today and said they’re not going to raise any more rates until next year and they’re looking at a secondary inflation event, causing bigger problems for the European Union and the UK. I don’t want to leave the UK out of it because they got drought issues and transportation inflation issues to deal with all, but there’s no silver lining for the next six to twelve months, in my opinion.

I think the euro is actually going to go down to 95 subparity for quite a while. 

TN: This year? 

AM: At the end of the year and into next year. Okay, so let me ask a couple of questions about markets and politics in Europe. First of all, how will this environment impact European politics in the near term? I expect the German coalition to break apart probably sooner than later. These inflationary effects are going to cause big problems. I mean, just the energy costs alone in Germany, God help them if they see frozen Germans dying, elderly people dying over the winter. It’s just a political nuclear bomb over there.

TN: Okay. Italy, places like that, obviously? 

AM: Italy is a disaster. Italy has always been a disaster. It’s just like their government’s rise and fall with the wind.

TN: UK, same? Do you think we’ll have a very short term government form and then it will fall away next year or something like that?

AM: Yeah, I believe one year. One year will last about a year. The French government is a little more stable, but even then McCrone lost the majority there. But Europe right now is in turmoil. The Dutch. Same problems with the Dutch. All these coalitions that have slim majorities are just going to start breaking apart. Okay, so ECB has kind of lost its backbone. European politics is in disarray. The Euro is likely to devalue or depreciate to 95.

TN: How are you playing, in a broad sense, equities in Europe? Do you think it’s a real danger zone for the next six months? Or again, are there broad equities? 

AM: When, there’s blood in the water you want to start buying. I would look at what’s systemically important to the European Union, like Deutsche Bank, French Bank Societe Generale, BASF.

These systemically important components to the economy have to be shored up so they’ll get bailouts

of support or whatnot and stimulus packages. That’s where. I’d be buying probably in January, February. 

TS: I think we’re already seeing a ton of bailouts, particularly in utilities right now. And so obviously those are going to help those stock prices. And so I expect we just hit the tip of the iceberg with Unifer. Right. And there’s a lot more to come. Those are the sectors that I would be watching.

TN: Wow, that’s pretty bad news. Okay. 

AM: It’s almost to the point where European equities will be cheaper than Chinese equities. That’s what we’re getting to.

TN: Okay, that’s good to know. We’ll keep an eye out for that. Okay, let’s move on to inflation. So everyone’s covered CPI and PPI this week. Please don’t turn off the show right now. We’re going to say something, but I did a survey yesterday. Very scientific, very statistically valid, Twitter survey yesterday looking at in light of CPI and PPI, where do we think Fed rates will go? And it’s pretty much a tie between 75 and 50. So I wonder, guys, we heard for days. There was zero month-on-month inflation, right? CPI inflation. And we saw negative. PPI. These are the things that you look at when there’s hyperinflation. We can’t find good news in the year on year. So let’s look at incremental data. So do you think we’ve hit peak inflation in the US?

AM: No. Secondary effect of inflation coming, mainly because the Fed started to rally this market for political optics. Commodities are rising. I mean, they’ve tried so hard to keep oil and wheat down, and it just simply will not break certain levels. It just won’t go down. Stay in 80s for the oil. It won’t break 750, 770 in wheat. And they just can’t do it. They have to go after these things, but they can’t during the election season.

TN: Okay, so you bring a good point with crude oil. There has been a lot of attention and work to keep crude oil prices and gasoline prices down. Tracy, how long can that happen? Because really, a lot of the zero or negative is in energy, right?

TS: Exactly. And I think what we’re seeing a lot here especially if you look at the front line, is I think we have a lot of things going on right now with the fact that as much Russian crude oil wasn’t taken off the market that people initially thought. There were recession fears. The SPR garage are really starting to weigh on that front month. So there’s a lot of things going on here that are kind of weighing on that front month. Plus open interest is nothing. And we also have China is still on their zero COVID policy and hasn’t opened up yet. So there’s a lot of things weighing on that the market right now. That said is that as soon as the SPR stops, which is end of October, coincidentally near in the Midterms.

Once that stopped and I still think Xi is going to have to open up China somewhat near the People’s Party Congress. And so I think that looking into the end of 2022 and into 2023, we definitely could see those higher oil prices again regardless of what the Fed does.

TN: Okay. Now, compound that real quick, compound those oil prices rising with the cost of rent going up astronomically and I don’t know what magic they’re going to be able to pull to keep CPI under 10%. What month? Like October, November, December?

AM: October, November. December. Okay. Smack in the middle of the Midterms. And they got to be seeing this. They have to be seeing it. If they’re not seeing it right now, it’s purely because the White House is interfering and wants politically driven news for the markets right now. 

TN: Okay, so do you think like a slight pivot to 50 basis points in September is possible or likely and then that eases up,  helps markets out, goose’s markets going into the Midterms and then we start to see this inflation rush come on and say late October, November?

AM: Well, first of all, we have to see what Powell says at Jackson Hole. Whether he’s dovish or hawkish. This rally makes me think that he’s going to have to be hawkish. Right. And then we’re still looking at probably a 50 basis point rate hike in September and after that I don’t want to even project what happens after that because it really depends on what CPI is going to be printing.

TS: Agree with that. 

TN: Okay, perfect guys. So you’re talking about markets rallying. Let’s talk about the week ahead. Equities have done pretty good this week, right? And commodities have done pretty well this week as well. So what are we looking for next week? You say volume is thin. Okay. So do we have another thin

volume week next week? Markets get goose, people feel good and then they come back the following week and we see some drama? What are you expecting?

AM: Yeah, I think that they could take this up closer to 4320 in the S&P. I think that’s the 200-day moving average, if I’m not mistaken. So they could take it up to there. But I’ll tell you what, looking at some of the order books on the S&P on the Futures, there is a boatload of sellers from 4260 to 4300. That boatload of them. 

TS: Yeah. It’s summer, right? Theres… Next week is the same as this week. You’re not going to see much until we hit September and fund managers and everybody’s back from their holidays. So I think we’ll see much of the same. The thing is that retail keeps trying to short this, which is kind of just a fuel to push this market higher because of liquidity issues. I think next week will be kind of the same. I’m not looking for outside of any disastrous thing happening, which hope not. But I think we’re going to stay in this well probably throughout the rest of August.

TN: And one of the things that I want to start thinking about, this isn’t the week ahead, but this is kind of the months ahead. I wonder if what happens if Russia Ukraine gets settled in October, November? That changes calculations pretty dramatically. So I’m starting to work on that hypothesis as well.

AM: Yeah, it depends on what a settlement is and whether Western sanctions still continue to bite the Russians, which are obviously going to retaliate economically. So a lot of the definitions need to be dealt with there.

Categories
QuickHit

Europe’s economic recovery: More like Japan, China or the US?

Europe's economic recovery like Japan, China, or US?

We have a first-time QuickHit guest for this episode, Daniel Lacalle, a well-respected economist, author and commentator. Daniel shares his expertise on the eurozone and European Union. What is happening there in terms of Covid recovery? How does the region compare to other economies like Japan, China, or the USA? Will the ECB follow what the BOJ did? Will there be talks of deflation or inflation in Europe? How about the quantitative easing especially with a possibility of a more conservative ECB chair? Also, will Europe suffer the same power crisis as China and will Europeans be able to absorb inflation?

 

Daniel Lacalle started his career in the energy business and then moved on to investment banking and asset management. Right now, he’s into consulting and also macroeconomic analysis and teaches in two business schools.

 

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This QuickHit episode was recorded on November 18, 2021.

 

The views and opinions expressed in this Europe’s economic recovery: More like Japan, China or the US? Quickhit episode are those of the guest and do not necessarily reflect the official policy or position of Complete Intelligence. Any contents provided by our guest are of their opinion and are not intended to malign any political party, religion, ethnic group, club, organization, company, individual or anyone or anything.

 

 

Show Notes

 

TN: We spoke a few weeks ago on your podcast, and I’ve really been thinking about that since we spoke, and I wanted to circle back with you and talk about Europe. There’s a lot happening in Europe right now, and I think on some level, the US and China get a lot of the economic commentary. But really, Europe is where a lot of things are happening right now. And I’d like to generally talk about what is the near term future for Europe. But I guess more importantly, in the near term, what are some of Europe’s biggest economic impediments right now? I’m really curious about that. So what do you see as some of their biggest economic impediments.

 

DL: When we look at Europe, what we have to see from the positive side is that countries that have been at war with each other for centuries get along and they get along with lots of headlines. But they’re getting along sort of in a not too bad way. Good. Yeah, that’s agreed. But it is true that the eurozone is a very complex and a very unique proposition in terms of it’s, not the United States, and it’s not unified nation like China. It’s a group of countries that basically get together under the common denominator of a very strong welfare state. So unlike China or the United States, which were built from different perspectives. In the case of the eurozone, it’s all about the welfare state as the pillar.

 

DL: From there, obviously, productivity growth, job creation, enterprises, et cetera, are all, let’s say, second derivative of something that is a unique feature of the European Union. No, the European Union is about 20% of the world’s GDP, about 7% of the population, probably. And it’s about 55% of the social spending of the world. So that is the big driver, 7% of the population, 20% GDP, 55% of the government spending in social entitlements.

 

So that makes it a very different proposition economically than the United States or China. Where is the eurozone right now? The eurozone and the European Union in particular were not created for crisis. It’s a bull market concept. It’s a Bull market agreement. When things go swimmingly, there’s a lot of agreement. But we’ve lived now two crisis. And what we see is that the disparities between countries become wider when there is a crisis, because not everybody behaves in the same manner. Cultures are different. Fiscal views are different. So that is a big challenge. The situation now is a situation that is a bit of an experiment because the Euro has been an incredible success. When I started.

 

DL: When I started in the buy side, everybody said the Euro is not going to last. And there it is. And it’s the second world reserve currency in terms of utilization, significantly behind the United States. So it’s been a big success. But with that big success comes also a lot of hidden weaknesses. And the hidden weaknesses are fundamentally a very elevated level of debt, a very stubborn government spending environment that makes it very difficult for the European Union and the eurozone to grow as much as it probably could. And it also makes it very difficult to unify fiscal systems because we don’t have a federal system. We don’t have like the United States is.

 

The situation now is the eurozone is recovering. It’s recovering slowly. But some of those burdens to growth are obviously being very clear. Think about this. When Covid19 started, estimates from all global entities expected China to get out of the crisis first, the eurozone to get out of the crisis second, and the United States to be a distant third. It’s… the United States has surpassed its 2019 GDP levels. The eurozone is still behind. So it’s interesting to see how the expectations of recovery of the eurozone have been downgraded consistently all of the time. And therefore, what we find ourselves in is in a situation in which there’s almost a resignation to the fact that the eurozone in particular, but also the European Union. The eurozone is a small number of countries. The European Union is larger, for the people that are watching. It’s going to recover in a sort of almost L shape. It was going to recover with very low levels of growth, with much weaker levels of job creation and with a very significant and elevated level of debt. So that’s basically where we are right now.

 

Obviously, the positives remain. But it’s almost become custom to accept low growth, low job creation, low wage growth and low productivity.

 

TN: It seems to me that if we switch to say, looking at the ECB in that environment, how does the ECB deal with that in terms of higher inflation, lower growth, a weakening Euro? Now, I want to be careful about saying weakening Euro. I don’t necessarily think the bottom is going to fall out. I know there are people out there saying that’s going to happen. But we’ve seen over the past, particularly three weeks, we’ve seen some weakness in the Euro. What does that look like? Do we see kind of BOJ circuit 2012 type of activity happening? Or is there some other type of roadmap that the ECB has?

 

DL: It’s a very good comparison. The ECB is following the footsteps of the Bank of Japan. In my opinion, in an incorrect analysis of how the ECB the European Central Bank behaved in the 2008 crisis. There is a widespread of mainstream view that the ECB was too tight and too aggressive in its monetary policy. Aggressive in terms of hawkishness in the previous crisis. And if it had implemented the aggressive quantitative easing programs that the Federal Reserve implemented, everything would have gone much better. Unfortunately, I disagree. I completely disagree.

 

The problems of the eurozone have never been problems of liquidity and have never been problems of monetary policy. In fact, very loose monetary policy led to the crisis. Bringing interest rates from 5% to 1%. Massively increasing liquidity via the banking channel, but increasing liquidity nonetheless. And so the idea that a massive quantitative easing would have allowed the eurozone to get out of the crisis faster and better has been also denied by the reality of what has happened once quantitative easing has been implemented aggressively.

 

So now what the ECB is doing is pretty much what the Bank of Japan does, which is to monetize as much government debt as possible with a view that you need to have a little bit of inflation, but it cannot be high inflation because in the United States, with 4% unemployment, 4.6% unemployment, you may tolerate 6% inflation. For a while. But I can guarantee you that in the European Union, in the Eurozone with elevated levels of unemployment and with an aging population, very different from the United States. Very different in the European Union almost 20% of the population is going to be above 60 years of age pretty soon. Aging population and low wages with high unemployment or higher unemployment than in the United States. A very difficult combination for a very loose monetary policy.

 

The Bank of Japan can sort of get away with being massively doveish because it always has around 3% unemployment. So structural levels of unemployment. But that’s not the situation of the eurozone. So I think that the experiment that the ECB is undertaken right now is to be very aggressive despite the fact that the level of inflation is significantly higher than what European citizens are able to tolerate. Obviously, you say, well, it’s 4% inflation. That’s not that high. Well, 4% inflation means that electricity bills are up 20%, that gasoline bills are up another 20%, that food price are up 10% so we need to be careful about that.

 

So very dangerous experiment. We don’t know how it’s going to go. But they will continue to be extremely doveish with very low rates. That’s why the Euro is weaker, coming back to your point. Extremely dovish despite inflationary pressure.

 

TN: So it’s interesting central banks always act late and they always overcompensate because they act late. So do you think that maybe a year from now because of base effects, we’ll be talking about deflation instead of inflation like, is that plausible in Europe, in the US and other places, or is that just nonsensical?

 

DL: Well, we will not have deflation, but they will most certainly talk about the risk of deflation, because let’s start from the fact that the eurozone has had an average of 2% inflation. In any case, most of the time. There’s been a very small period of time in which there was sort of flat inflation. Right. So will they talk about the risk of deflation? Absolutely they will. I remember the first time I visited Japan. I remember talking to a Japanese asset manager and saying, “well, the problem of Japan is deflation, isn’t it?” And he said to me, you obviously don’t live in this country. So will they talk about deflationary pressures? Maybe. Yes.

 

Think about this. If you have 5% inflation in 2021 and you have 3% inflation in 2022, that is 8.1% inflation accumulative. But falling inflation.

 

TN: Right. Exactly. Yeah. And it could be a way to justify central banks continuing to ease and continuing to intervene. And so Japan’s found itself in a really awkward position after eight, nine years of really aggressive activity. It’s just really hard to get out once you stop, right? So I do worry, especially about the heritage of the ECB, with kind of the Dutch and German chairs being very conservative. This is a pretty dramatic change for them, right?

 

DL: Huge. Because you’ve mentioned the key part is that everybody says, well, the ECB will do this. The ECB will do that. But the problem is that the ECB cannot do most of what they would consider normalizing. Because Spain, Portugal, Greece, Italy, it would be an absolute train wreck if the ECB stops purchasing sovereign bonds of those countries. Because the ECB is… This is something that you don’t see in the United States. The ECB is purchasing 100% of net issuances of these countries.

 

So what’s the problem? Is that? Think about this. Who would buy Spanish or Portuguese government bonds at the current yields if the ECB wasn’t buying them? Nobody. Okay. Let’s think of where we would start to think of purchasing them. We would probably be thinking about a 300-400% increase in yields to start thinking whether we would purchase Portuguese, Greek, Italian, French bonds? Not just the Southern European, but also France, et cetera.

 

So I think that is a very dangerous situation for the ECB because it’s caught between a rock and a heart place. Very much so. On the one hand, if it normalizes policy, governments with huge deficit appetite are going to have very significant problems. And if it doesn’t normalize, sticky inflation in consumer goods and nonreplicable goods and services is going to generate because it already did in 2019, protests. Because we tend to forget that in 2018 and 2019, we had the gilets jaunes, you probably remember the Yellow Vests in France. You probably remember the protest in Germany about the rising cost of living. The protests in the north of Spain. So it’s not like everybody is living happily. It’s that there were already significant tensions.

 

TN: Right? Yeah. I think the pressure is, the inflationary pressures that say consumers are feeling here in the US and Europe and parts of Asia, definitely acute, and people are talking more and more about it.

 

If we move on to say specifically to energy, since that’s where you came out of, right? So we’re seeing some real energy issues globally and energy prices globally. But when we look at gas, natural gas, specifically in Europe, do you expect to see a crisis in Europe like we’ve seen in China over the last three months where there are power outages, brownouts, hurling blackouts, that sort of thing? Or do you think there’ll be a continuity of power across Europe?

 

DL: In my opinion, what has happened in China is very specific to China because it’s not just a problem of outages because of lack of supply. Most of the lack of supply problem comes from a shortage of dollars. So many companies in China have been unable to purchase the quantities of coal that they required in a rising demand environment because they had price controls and therefore they were losing money.

 

They would have to purchase at higher prices and generate at a loss. That is not the case in Europe. In Europe, the problem of gas prices is a problem of price definitely, obviously. It’s very high and it’s also feeding to our prices because of the merit order. But it’s not a problem of supply in the sense that getting into an agreement with Russia to increase 40% their supplies of natural gas into the European Union was extremely quick. From the 1st November to beginning of this week, gas form has increased exports to Europe by 40%.

 

Problem? Prices have not fallen as much as they went up before. For the south of Europe, it’s a problem fundamentally, of access to ships because LNG obviously is very tight. Vessels are not available as they used to be. There might be a certain tightness in terms of supplies, but I find it very difficult to see, let’s say, a Chinese type of shortage of supply because it’s a matter of price. Will we have to pay significantly more for natural gas and significantly more for power, but not necessarily feel the problem that the Chinese did because they had lost making generation in coal.

 

TN: Great. Okay, that’s very good. That’s what I’d hoped you say, but it’s great to hear that. Let’s switch just a little bit and talk about kind of European companies because we talked about rising prices, like energy. We talked about inflation and consumers say bearing inflationary pressures.

 

In European companies, we’ve seen that American companies have been able to raise prices in America quite a lot, actually. And consumers have borne that. Chinese companies haven’t really been able to do that. Their margins are really compressed because consumers there haven’t been able to bear the price rises. What are you seeing in Europe, and how do you think that impacts in general European companies, their ability to absorb price rises or pass them on to consumers? And how long can they continue to bear that?

 

DL: Yeah. One of the things that is very distinct about Europe is the concept of the so called, horrible name, “National Champions.” In power, in telecommunications, in banking, in oil and gas, etc. Etc. We tend to have each country a couple of dinosaurs, most of them, that are so called National Champions. These cannot pass increases of inputs to final prices because they receive a call from the red phone from the Minister in the country. And no my friend, the prices are not going up as they probably should.

 

So the automotive sector? Very difficult because there’s a lot of over capacity and at the same time, tremendous cost pressure that you cannot pass because of the lack of demand as well, or the lack of demand relative to supply. The airline sector? Cannot pass the entire increase of cost to consumers. The power sector? Very difficult, big companies, very close to governments. They’re suffering immensely from regulatory risk. So very difficult. So you have those.

 

However you would say, okay, so that sort of shields inflationary pressures out of consumers. Unfortunately, it doesn’t because those are very large companies, but they’re very small in terms of how much they mean, for example, the prices of food or the prices of delivered natural gas. Even though you purchase natural gas, there’s a strict pass through in those, for example. You might not increase your margins. You might lose a little bit, but the pass through happens. It goes with a delay. In the United States, everything happens quickly. In the United States, shut down the economy, unemployment goes to the roof, then it comes down dramatically like V shape, opposite V shape. In the Eurozone, things happen slower. And that’s why it’s a bigger risk, because the domino effect, instead of being very quick and painful and quickly absorbed is very slow.

 

TN: Interesting. Okay. Very good. Well, Daniel, thank you for your time. Before we go, I’d like to ask everyone watching. If you don’t mind, please follow us on our YouTube channel. That helps us a lot in terms of adding features to our podcast.

 

Daniel, thank you. As always, this has been fantastic, and I hope we can come back and speak to you sometime in the future. It will be a great pleasure. Always a fantastic chat. Thank you very much.

 

DL: Thank you very much.