Charts of the Week: EU on the Brink
- By Matthew Tibble
- 2 min read
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Summary
- Risk case: EUR/USD to 0.80.
- US growth doesn’t look that bad…
- Russia holds EU hostage via energy.
- The ECB is in a bind.
In an Alternate(?) Future…
Given the euro’s recent decline to parity with the dollar, a pre-mortem could be useful. After all, most analysts have simply taken that breach as opening up the risk of a move to 0.95 – a classic case of chasing the market and lacking an imagination as to what could happen. The more interesting case would be a drop to the 2000 low of 0.82, or even 0.80 (Chart 1). We explore what that would look like here, in the first of our new Pre-Mortem reports.
Underlying Growth Trend Looks Strong
If you strip out the volatile components of GDP, inventories, net exports and government spending (i.e., look at final sales to domestic purchasers), you can see that the underlying trend remains strong (Chart 2). That is one reason Dominique believes more aggressive Fed tightening will be needed for a fully fledged recession.
EU on the Brink?
The outlook for Europe is highly uncertain. This week will be critical. With a war on its border, the risks of fallout to the EU have been elevated for some time. However, the recent restrictions in Russian gas supply and the current shutdown to Nord Stream flows has focused the market on how that fallout may happen (Chart 3). We have previously covered the catastrophic economic ramifications of a gas supply cut. If Russia refuses to reopen the Nord Stream flow this Thursday (21 July), or even if the probability of that rose (such as Russia announcing new threats/conditionality around it), European equities could go into freefall. We explore trades here.
Energy Driving EU Inflation Overshoot
With Russia holding the EU hostage over energy, inflation in the bloc is rising rapidly (Chart 4). The ECB is in a bind ahead of their meeting tomorrow. The economy is deteriorating, Europe’s energy supply is unclear, and political uncertainty has reached Italy again. The Governing Council want to tighten, but their panic at the widening seen in BTP/Bund back in June suggests their appetite to break things (economic growth / cheap periphery funding) to do so is limited. We explore more in our ECB preview.