The debate at the forefront of investors’ minds these days is when the recession will hit the global economy, with a timeline ranging from 2023 to possibly the middle of 2024. As economists try to debate the merits of a recession, what most fail to realize is that we are in fact already in the middle of one.
The behavior of markets and asset prices is such that they tend to weaken first and then the data prints to confirm it after the fact. But by then it is too late.
US government officials, including the Fed, are working very hard to hide the fact that we are indeed in the midst of a recession per se, even though the textbook definition calls it one. Two consecutive quarters of negative GDP growth may be followed by another judging by how the third quarter is shaping up.
Investors often tend to focus on the US economy, but it is much more resilient than Europe and the rest of the world, not to mention that the US central bank is one of the largest and most powerful that dictates price action for a multitude of economies and currencies.
After the Covid-induced demand surge, all economies suffered from high consumer and producer prices and faced the same trend of weaker disposable wage income growth in the face of an increase in the cost of living . This puts a serious brake on the average consumer and therefore on the GDP of this country. As central banks tighten, these prices come down, easing some of the inflationary pressures, but make no mistake, we continue to hold average inflation closer to 8% year-over-year.
Europe’s systemic problem
The problem for Europe is that in addition to these trends, it faces a more systemic problem, namely extremely high debt levels and an end in sight to rising gas and electricity prices. Europe is so dependent on Russian gas that its invasion of Ukraine has really torn countries between those who want to sanction Russia for their actions and those who cannot given their country’s dependence on these gas flows. .
Europe plans to end oil and gas imports from Russia towards the end of the year, but that’s still a few months away, even though it has absorbed a lot more LNG from the United States. . Given the price arbitrage and the difference between the US, UK and Europe, US LNG players are able to take advantage of the huge price difference and reroute their cargoes to Europe. The EU imported 21.36 million tonnes of LNG in the first half of 2022, compared to 8.21 million tonnes in the same period a year ago, according to ICIS.
In recent months, Europe has managed to steadily build up gas reserves by curbing demand and switching from gas to coal for some power plants. Everything talked about at COP26 has been reversed as China and the rest of the world ramp up coal production to meet their electricity and gas needs.
Today, European gas storage levels are 70.54% full, exceeding the 5-year average of 70.32%, according to data from Gas Infrastructure Europe (GIE) released on Thursday. Levels were also not far from a ten-year average of around 71.40%. The market is still nervous as winter approaches due to the surge in heating demand, but the situation is much less serious now than it was a few months ago.
European gas prices have risen from 75 euros/mwh to over 200 euros/mwh since the beginning of this year. Gas and electricity are not like oil, there is a limited quantity that must be stored before any season to anticipate the increase in demand. Given the scale of Russian flows or winter demand, prices could very well remain high for a long time despite the economy entering a manufacturing recession as Chinese demand slows.
Right now the Fed is in a position to raise rates to fight this inflation, but we know the ECB is not in a position to raise rates given the scale of their debt and their lack of productivity. It can’t even afford more than a 50 basis point rate hike. It shows in their balance sheet, the fact that the ECB has failed to even balance it even in good times.
It’s easy to look at market moves over the summer and try to fit a narrative to justify the move. But beware, lack of liquidity and extremely bearish positioning tend to cause oversold rallies. Saying that the Fed is now dovish is another matter altogether.
Global growth is collapsing and central banks are no longer able to get out of their dilemma, at least not until inflation falls rapidly. Even if the US manages to stage a soft landing, the Fed still has around 250-300 basis points to cut if needed. Europe does not even have a 50 basis point margin. Commodities are all about timing, and America’s energy independence allows it to weather the storm much better than Europe, which will be forced to pay higher prices for the goods it needs and she consumes.