The Beast from the East

Could a looming recession in Europe actually be good news?

In one respect yes, for gas prices and household energy bills. Gas prices soared in the wake of Russia’s invasion of Ukraine and Europe’s frantic scramble to store gas for winter and to reduce its dependence on Putin’s gas supplies.

However, gas prices have started to fall sharply. Very mild weather in October has been helpful. In addition, European gas storage facilities which were seeking to achieve 80% capacity by the end of October are reported to now be 95% full. Furthermore, the slowdown in economic activity across Europe means that some big gas consuming industries such as steel and cement production are using less gas. Europe currently has more natural gas than it can use. Longer-term falling gas prices could even be helpful for the UK government if household and business energy bills prove to be not as high as feared. This might require less support with energy bills and not as much government borrowing.

Liquified Natural Gas (LNG) has played a key role in allowing Europe to fill storage capacity and keep the lights on. While LNG tends to be supplied under very long-term contracts, it is nonetheless a global market which allows specialised LNG tankers to sail to the highest spot price market. Europe is in competition for LNG with Asia. Japan and South Korea are big LNG users along with China. However, with lower demand and falling prices, LNG tankers are waiting standing idle off the coasts of Spain, Portugal, and even the UK. It has been estimated that c.20% of the World’s fleet of LNG tankers are parked up off Europe waiting for prices to move higher. Unusually, European spot prices for gas briefly went negative last week.

In time, Europe will further diversify energy and shift away from gas. However, the growth in renewable sources will take time and winter 2024 and 2025 could still be a challenge. For now, we need gas to keep homes warm and generate electricity. The real question is what happens next? Gas prices will depend in varying degrees, on the war in Ukraine, winter weather, the growth of renewables, global demand for gas and the hundreds of LNG tankers sailing either east or west.

For now, it’s a warm wind from the Canary Islands that blows everyone good – apart from Putin – let’s hope it stays mild for as long as possible!

What have we been watching?

The swift ‘election’ of PM Rishi Sunak was greeted with relief by investors. In the US, it was back to the ‘bad news is good news’ investment mantra with weak business activity indicators adding to hopes of a potential ‘Fed pivot’ pause, if not an outright pivot. America’s biggest technology companies had a combined $250bn wiped off their market value after disappointing third-quarter results not helped by a combination of weak consumer sentiment and a strong Dollar. A big week ahead for a number of central banks with interest rate hikes and updated outlook guidance including the US Federal Reserve (Fed) and Bank of England. With evidence of a slowdown in economic activity, investors are now anticipating a reduced pace of interest rate hikes from the leading central banks. Inflation remains elevated, but the pressure from some of the main upward drivers such as gas prices has moderated significantly although food prices are likely to remain high.

The S&P Global PMI indicator for October showed a contraction in business activity for the fourth straight month in a row. Within this, the ‘flash’ data suggested that Europe is heading into recession in the final quarter of 2022. The Eurozone composite PMI dropped to 47.1, which was almost a two-year low. Germany deteriorated further with a PMI of 44.1, the weakest data since 2009. The UK composite PMI (manufacturing and services) remained in contraction territory for a third straight month in a row. The US dipped into contraction territory with a reading of 49.9. The one exception was Japan which increased to 51.7 with manufacturers/exporters helped by the weak Yen relative to the Dollar.

Russia has halted a deal allowing Ukraine to export grain from ports in the Black Sea and has launched missile attacks on power infrastructure in a number of Ukrainian cities after a Russian warship was damaged during drone attacks in Sevastopol.

In the UK, the swift ‘election’ of new PM Rishi Sunak was greeted with relief by investors with Sterling rallying to above $1.15. Government gilt yields pretty much back to where they were before the ‘mini-budget’ with the yield on the 10-year gilt falling last week from 4% to under 3.5%. Mortgage rates also appear to have come back slightly from the recent peak. The fiscal plan has been delayed until the 17^th November and will now formally become the government’s Autumn Statement. This will give the new PM and Chancellor more time to consider cost cutting and tax plans as well as allowing the OBR forecasts to reflect the recent decline in the cost of borrowing. This could be as much as £6bn! However, the delay is not so helpful for the Bank of England which meets later this week and markets are starting to think the central bank may take the less painful option with a 0.5% rather than 0.75% hike. Interest rate futures are currently forecasting a peak below 5% compared with nearly 6% following the Kwarteng ‘mini-budget. Meanwhile, the UK’s largest mortgage lender, Lloyds Bank expects house prices to fall by 8% in 2023 and then almost stagnate for the following four years.

The European Central Bank (ECB), as expected increased interest rates by 0.75%. However, there appeared to be a slightly more ‘dovish’ tweak in the accompanying statement with the ECB saying interest rates would need to be raised ‘further’ compared increases needed over the ‘next several meetings.’ Following hikes in total of 2% in barely three months, market expectations for the Eurozone deposit rate now imply around 2.6% next year.

In the US, the average 30-year mortgage rate climbed to a new 20-year high of almost 7.2%. The US Consumer Confidence Index was weaker than expected and a number of US ‘big tech’ names including Amazon reflected this softer outlook in disappointing third quarter results. However, US economic growth in the third quarter was 2.6% although this appeared to be driven by business trade rather than consumer spending.

President Xi Jinping said China and the US must ‘find ways to get along.’ US Secretary of State Andrew Blinken said China has rejected the status quo on Taiwan, re-iterating his assessment that Beijing has speeded up its timeline to take the island.

Brent Oil edged up to $95 as concerns about tightening supplies countered falling demand forecasts.

Finally, talking of household energy bills, Easyjet has launched an ‘Escape the UK’ holiday to Egypt which it claims will be cheaper than staying in the UK this winter. The 28-day all-inclusive package costs £650 per person to stay in a 5-star hotel in Hurghada. Easyjet believes this could be £227 cheaper per person than the average UK household cost for rent, travel, food, plus bills for energy, water and TV/Wi-Fi in a month. Meanwhile, UK pub group Young & Co is offering a ‘work from the pub’ package Monday to Friday 11am to 4pm for £15 with unlimited tea and coffee. You have to admire business ingenuity!

Read Last Week’s Alpha Bites – A restless dragon

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The Beast from the East

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