The recovery in markets (and risk assets generally) from the mid-June lows proceeded well until around the middle of the month, then everything turned sour again.
The S&P 500 had regained more than half of the year’s falls by mid-August, prior to turning down again, similarly the tech-heavy NASDAQ recovered almost exactly 50% of the falls before turning off.
Bond yields drifted back to lows of 2.6% for the US ten-year and 1.8% for the UK ten-year on 1st August, encouraged by a pleasant surprise from the US inflation report for July. This all reversed over the subsequent three weeks, taking the US back up to 3% and the UK to 2.5%. In the UK, the move has been even more marked at the short end where two-year yields have risen from 1.7% on 1st of the month to 2.6% now. The move has been similar at the long end though duration, as ever, has left its mark: the thirty-year Gilt has fallen 12.5% over the period, the two-year by 1.5%.
It is all about inflation. The UK CPI figure for July was not a pleasant surprise at 10.1%, worse than anticipated and the first of the major economies to move into double-digit inflation. The price of oil has actually slipped back around 8% over this period, with lower gasoline prices in America being a decent contributor to their improved figure, but Europe (and the UK) is at the mercy of the price of gas, which has gone ballistic in recent weeks. In turn, this has led to a competitive race to forecast ever higher rates of inflation, a doubtful exercise in the current febrile conditions.
Of course, the cold hand of Vladimir Putin (and his vassal Gazprom) is behind this as he plays games with the availability of gas via the Nord Stream 1 and 2 pipelines. Despite this, Germany and the EU are on track to prepare for the cold season by storing more gas. To quote Berenberg:
In the seven days from 13 to 20 August, storage levels rose from 74.4% to 76.9% of capacity for the EU as a whole, and from 76.1% to 79.5% for Germany (source: AGSI). On current trends, the EU looks set to exceed its 80% storage target in early September. Even more exposed Germany may get close to its 95% target in early October.
This probably means that Germany will be able to get through the winter unscathed but does not tackle the longer-term issue. Which is not to say that all will be well. If these pipelines remain closed / very limited and the winter is harsh, then there are still likely to be shortages and possibly rationing.
Naturally, the lurid headlines and forecasts are taking their toll on confidence amongst consumers and businesses and the short-term prospects for the UK and eurozone are bleak. Price rises of the scale of the past week will also have a direct and sizeable impact on growth. We fully expect the US Federal Reserve to lift the Fed Funds Rate again in September and, similarly, we expect the (beleaguered) Bank of England to do the same. Quite what impact this might have on inflation at present is open to question, it will certainly add to the slowdown.
Energy price increases of this magnitude are shocking for consumers and economies and render the energy policies of much of Europe and the UK completely untenable. Short-term the problems of those individuals (and companies) who simply cannot afford this must be addressed, but longer-term energy policy is the major issue now (shame about fracking).
I should also point out that it is August. The holiday month in Western Europe, markets are quiet, thin and tending to the illiquid. Europe and its gas market must have looked like a soft target to Putin. The only consolation is that he has almost certainly destroyed any final vestiges of trust and wholly alienated his biggest customer, which, in time, should condemn the Russian economy.
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