Mind the gas.
As the war lasts more than broadly anticipated, risks around gas supplies for Europe increase. Economic and financial linkages with Russia have essentially been cut entirely over the past month, with the exception of oil and gas supplies. Commodity exports are thus the natural candidate to represent the next level of tensions between Russia and Europe. This week, Russia made some step in this direction announcing that, going forward, payments for LNG will be accepted in Rubles only (instead of hard currency, as currently). While details have not been published yet, this is likely to amount to a de facto renegotiation of the existing contract with Gazprom. As such, we believe major countries are unlikely to accept the new terms, especially under newly introduced financial sanctions regime. Europe and US have revealed a soon announcement of a new energy plan, likely disclosing new investment in alternative energy supply and alternative sources. Still, a proper replacement of Russia energy dependence will take time, as Russian gas represents 25% of global supply and major European countries have low stocks (3-4 months of inventory at best). A sudden move by Russia increases the probability of a short circuit-breaker in energy markets, i.e., a situation where access to existing supply is prevented but new supply is still to be generated. We thus see recent news as a small increase in tail risk and remain cautious on inflation and rates dependent assets amid potential for more sudden commodity upside.
EZ PMIs – Recession fears vastly exaggerated.
European PMIs for March show some sign of slowdown, but arguably less then feared. The index came out at 54.5, one point below February but still well in expansionary territory. Output growth and manufacturing show a small contraction contrasted with the February index – despite lighter Covid curbs – suggesting some impact from the war is felt in the economy. Unsurprisingly, the supply side displays most issues. New industrial orders and export demand remain very weak, adding to concerns regarding the impact of commodity inflation and reduced trade. On the other side Germany, by far the largest economy in EZ, remain resilient compared to the periphery, and household surveys continue to display a good degree of confidence. Overall, the reading is in line with our view that the war may shave off some momentum from European growth, but talks of recession are largely exaggerated, at least at this point. We continue to think that the main implication of the war will be a strong increase in inflation, and further upward pressure in rates. Credit spreads have briefly hovered above 2018 levels despite stronger economic momentum, suggesting some value is emerging in EZ spreads. We thus maintain a prefer for spread risk over duration and continue to stay cautious on rates-sensitive assets.
Algebris Investments’ Global Credit Team
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