GLOBAL CREDIT BULLETS | Monday, 29th August 2022

Jackson Hole – Hawks come from Europe
The Jackson Hole symposium saw the ECB delivering a very hawkish message. In her remarks over the weekend, MPC member Schnabel clarified that the ECB needs to act forcefully on inflation irrespective of the source of inflation. As a result, hikes should take place even if energy supply is the driver, to preserve wage spirals and inflation expectations. Schnabel made clear that at the current juncture inflation ranks well above unemployment and growth, an unprecedented message for ECB standards.
The ECB appears very worried about upcoming inflation data (out this week for August), and recent EUR price action. The currency is at 5y lows in effective exchange rates terms, 2% below the lows reached earlier this summer and close to Covid lows. A faster step-up is thus needed to catch up with central bank peers and preserve confidence in the currency and anchor expectations. Following Schnabel speech, we think a 75bp hike in September becomes the base case and the market will need to price more 75bp steps, opening more upside for European rats.
The hawkish turn follows August PMI data in Europe, weak but not disastrous. This suggests that the ECB will now be hawkish but does not prevent quick turns if data worsen. As real rates stay deeply negative, the ECB can move rates quickly signaling more commitment to the inflation fight but having a limited impact on growth. So, for now we believe additional tightening has more advantages than costs, and the ECB will continue to press on the accelerator.
The message from Fed Chair Powell, on the other side, was not dovish but more in line with previous communication. The Fed moved already to a very data-dependent stance, so little guidance was given on future moves. Upcoming labor market and CPI data will be important and shape up the short-term path of policy rate. Multiple reference to the Volcker disinflation tilts the speech on the hawkish side, especially coupled with the new ECB stance.

European energy – Storage build-up not enough
The European gas crisis continues to accelerate, with Russia announcing new maintenance for the Nord Stream 1 pipeline (three days starting on Aug 31^st), and gas prices that continue skyrocket (up 50% in August only). Good progress in gas storage build-up and falling demand for gas may not be enough to offset European consumption needs for the winter months to come.
Likely flow reductions are partially offset by a broad build-up of storage capacity across Europe. Most countries have reached 95-90% storage capacity levels, with Germany (highly dependent on Russian gas) being ahead of its gas storage targets for August and on track to completely fill up capacity by Q4. Further, there has been a much larger-than-expected drop-off in demand as industry switches to other fuels.
Storage progress is welcome, but unlikely to be enough. Data from Gas Infrastructure Europe shows that, on an aggregate level, current storage levels will only be enough to cover about 21% of gas consumption in Europe. By country, at current levels of gas storage, Germany covers c.20% of its consumption, c.25% in France, c. 20% in Italy, c. 7% in Spain and only c.1% in the UK. The situation is overly complicated by the fact that gas consumption is not linear but concentrated in winter months.
In a nutshell, gas storages, even if filled to 100% of capacity, are not enough to cover gas consumption. The reduction in gas demand driven by the gradual switch to other sources will thus be key in determining how much rationing needs to take place in winter. Data show that the current flow (c.20% of pre-war levels) is sufficient to support European consumers at current storage levels, but a flow reduction from here is not sustainable. Gas market dynamics will thus continue to be the key driver of risk markets, and any longer-than-planned NS1 maintenance in late August may have large costs in terms of energy supply.

PMI surveys – Moderate weakness
PMI surveys for August in line with consensus, with some good news on the manufacturing side, where data surprised on the upside, especially in Germany. European PMIs remained around 49 (47 in Germany), a weak but not disastrous level. Experience in recent recessions suggest PMIs can drop another 2-3 points before bottoming, unless the gas picture worsens dramatically. The UK and the US saw bigger misses, respectively on the manufacturing and services side.
UK Manufacturing PMI saw a 6 point drop to 46 from 52.1, a large drop. The output component fell to 42, a deep recessionary level. Composite PMIs were not as bad with services holding up. The Composite reading came in at 50.9 vs an expected of 51 and previous reading of 52.1. In the US, Services PMI tumbled to 44.1 from 49.8 in July, below consensus estimates of 49.8. This is the lowest reading since May 2020. Whilst this reading can be volatile, it confirms falling activity in the US.
Eurozone PMIs fell further into recessionary levels, with the composite reading coming at 49.2 vs the previous reading of 49.9. Manufacturing data beat expectations across the board with Eurozone data coming at 49.7 vs 49 expected and a prior reading of 49.8. Services PMI slightly disappointed coming at 50.2 – below expectations of 50.5 – albeit higher than the manufacturing print on an absolute basis. France Services PMI particularly disappointed coming at 51 vs expectations of 53.

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Algebris Investments’ Global Credit Team