It’s been a relatively quiet week in financial markets
With many Asian markets closed for most of the week for Chinese Lunar New Year and an absence of central bank speakers with the Federal Reserve in their ‘blackout’ period ahead of their rate setting meeting next week.
We’ve heard from a few members of the European Central Bank, with the general mood among board members seeming to be a determination to continue raising interest rates to counter inflation, a path that is somewhat easier to follow given the drop in energy prices thanks to above average temperatures so far this winter. The lower energy prices mean that the ‘worst case’ scenarios for the impact on the wider eurozone economy has been averted, with analysts now rushing to upgrade their growth forecasts for the region. The economic data, while still poor, is far ‘less bad’ than expected, giving the ECB some more headroom to continue their fight against inflation without worrying about the economy hitting a wall. The benchmark European natural gas futures price is down 83% from the peak last summer, when European energy companies were rushing to fill capacity ahead of the winter. Eurozone gas storage is still 80% full, a level without precedent in recent years. The gas price is still double the 10-year average but the declines we have seen over recent months have certainly boosted the narrative around European growth. The EU has done well to diversify sources of gas supplies, though may well be competing with a reopening China for supplies this coming summer. The EU has also seen high prices drive energy efficiency, with gas usage 21% below the 5-year average in 2022. ECB President Christine Lagarde said, “we will stay the course to ensure the timely return of inflation to our target” while colleagues on the ECB board have all pointed to 50 basis point rate hikes at the next two ECB meetings before policy rates become more “data dependent”.
Of course, outside of the weather, the key catalyst for energy price moves remains the war in Ukraine, or more specifically, how much energy Russia is willing to continue to export. The conflict will likely remain in a somewhat gridlocked state for several weeks through the depths of the winter, though Ukrainian President Zelensky continues to call for western military aid ahead of an expected increase in Russian activity as they put the 300,000 troops called up last year to work. Zelensky has called for at least 300 tanks from the western allies and we have seen some notable moves this week, with Germany agreeing to supply tanks and approving the supply of German made tanks from other countries such as Poland. The UK and US have also committed tanks, along with armoured vehicles, artillery systems and ammunition. The Russian ambassador to the US called the increase in western support “another blatant provocation”. In the words of the playground, “you started it” seems a suitable retort. While financial markets feel like they have very much moved on from worrying about the conflict, with the focus more on a slightly more benign growth outlook helped by Chinese reopening, the potential for further energy disruption remains a tail risk, though continued efforts to diversify supply away from Russia will mitigate the problem.
Onto the economic numbers and again more evidence that the eurozone economy is faring better than feared. The flash PMI data for January was back above the 50 level – the dividing line between contraction and expansion – for the first time since last June, with the composite at 50.2, ahead of expectations. Services moved further into expansion while manufacturing remained in contraction but at a stronger pace. The equivalent UK data was more sobering, falling to a 2-year low and weaker than expected. The UK composite of manufacturing and services combined fell to 47.8. The US data was slightly better than expected but still pointed towards economic contraction for the 7th consecutive month with a composite figure of 46.6. That said, the Q4 GDP data published for the US yesterday suggested that the US is still some way from recession with annualised growth of 2.9% for the quarter, stronger than expected. Within the data there were signs of weakness, with much of the growth coming from government spending and higher inventories. Final consumer demand was sluggish. We heard from a fund manager this week who is now more worried about the US slipping into recession than the eurozone. That’s a big shift but it does seem like the consensus is becoming a little more sanguine on the economic outlook. How long this can last given the lagged impact of interest rate hikes remains to be seen. But with China’s reopening coming faster than expected, it does mean that there is potentially some more upside to the global growth figures than expected late last year.
