Oil markets – Back on a roll
Last week, oil turned more volatile once again.
Uncertainty over the amount of supply cuts and China re-opening have been the main driver of the volatility, with various headline heavily affect prices.
Current OPEC production restrictions remain consistent with the slowdown in demand, with oil now trading well below the levels of the October OPEC meeting, despite the supply cuts implemented. Lower oil will continue to be a key driver of the ongoing inflation slowdown.
The upcoming slowdown in global economic activity is consistent with lower oil, as recessions typically see oil prices falling to $65-70 levels. The difference this year can be China re-opening, which could bring China growth back to 5-6%, if confirmed. A big gap in economic growth between China and the rest of the world can be a positive tailwind for oil, as Asian demand would boom and the dollar would weaken. Overall, we continue to see higher oil via stronger Asian macro as one of the key upside risks to inflation in early 2023 (though our baseline remains for continued disinflation trend).
European inflation – Plateauing at least
We believe November inflation data for Europe, to be released this week, will finally stabilize, pointing to the peak having been reached in Europe too.
Based on our internal model, we expect inflation to drop to 10.5%, 20bp, driven by lower commodities, including natural gas, which is now 60% lower than in summer. Core inflation will prove stickier, and remain stable at 5% for the November print, as second round effects persist longer. Overall, we think inflation will continue to drop lower in the first quarter of next year, with headline reaching 8%, and core low 4%, before summer 2023.
This week, Germany industrial prices came in lower than expected with a strong downside surprise. November PPI was down 4.2% on the month, the first fall in Germany’s PPI since May 2020, suggesting that lower pressures in industrial prices could well be reflected in a milder inflation on CPI’s core goods. PMI data out this week also point to an easing pressure in Eurozone prices.
More stable inflation will pave the way to slower ECB hikes from the ECB. We think the central bank will slow down the pace of hikes to 50bp in December, bringing the deposit rate to 2.5%, and we continue to expect a terminal rate around 3%, in line with what currently priced (though the ECB is likely to initiate a very gradual quantitative tightening program at the December meeting too).
Algebris Investments’ Global Credit Team
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