Another Money Magic Tree Dries Up
- 11 July 2022 (7 min read)
Key points:
- We explore the risk of a protracted cut in Russian gas supply after the “maintenance period”.
- Fed hawks bolstered by the latest labour market data.
- That inflation helps with public finance is not a “law of the universe”. Europe is not experiencing “the right kind of price shock” from that point of view.
The beginning of a “maintenance period”, which is stopping the flow of Russian gas to Europe via Nord stream for 10 days, is focusing attention on the risk of a more protracted Russian embargo which could tip in the Euro area into a recession. A key issue is whether a comprehensive European solidarity mechanism pooling scare gas resources could be conjured up to support Germany and Italy. The current system designed by the European Union (EU) rests on a series of bilateral agreements which would be insufficient. We could easily picture a complicated “give and take” negotiation to get a stronger framework across the line, with France and peripherals arguing that the natural “complement” to such solidarity in the realm of energy supply benefiting Germany would be another push towards debt mutualization – the second stage of Next Generation EU (NGEU) which has so far been elusive. This would not be an easy discussion.
“Gas stress” is in any case pushing prices further up, jeopardizing the gradual deceleration in headline inflation which base effects would provide. In the US, “persistent inflation” is more likely to come from a lack of sensitivity of the labour market to the economic slowdown. From that point of view, the stronger-than-expected job creations in June unveiled last week strengthened the case of those at the Federal Open Market Committee (FOMC) who argue for another 75-bps hike.
The only benefit of inflation is its capacity to help with reducing public deficit and debt, as long as real interest rates don’t react too much. However, it is not a “law of the universe”. Drawing on Agnes Benassy-Quéré’s latest note we distinguish two cases. One when an economy is faced with overheating, and the GDP deflator rises in sync with consumer prices (close to the US current situation), and another where an exogenous shock dominates, and consumer prices rise much more than the GDP deflator (European situation). It is much harder to bring public debt back under control in the second case. While the current fiscal mitigation of the price shock is justified, it is not a “free lunch”. Painful decisions will have to follow.
Disclaimer
This website is published by AXA Investment Managers Australia Ltd (ABN 47 107 346 841 AFSL 273320) (“AXA IM Australia”) and is intended only for professional investors, sophisticated investors and wholesale clients as defined in the Corporations Act 2001 (Cth).
This publication is for informational purposes only and does not constitute investment research or financial analysis relating to transactions in financial instruments, nor does it constitute on the part of AXA Investment Managers or its affiliated companies an offer to buy or sell any investments, products or services, and should not be considered as solicitation or investment, legal or tax advice, a recommendation for an investment strategy or a personalized recommendation to buy or sell securities.
Market commentary on the website has been prepared for general informational purposes by the authors, who are part of AXA Investment Managers. This market commentary reflects the views of the authors, and statements in it may differ from the views of others in AXA Investment Managers.
Due to its simplification, this publication is partial and opinions, estimates and forecasts herein are subjective and subject to change without notice. There is no guarantee forecasts made will come to pass. Data, figures, declarations, analysis, predictions and other information in this publication is provided based on our state of knowledge at the time of creation of this publication. Whilst every care is taken, no representation or warranty (including liability towards third parties), express or implied, is made as to the accuracy, reliability or completeness of the information contained herein. Reliance upon information in this material is at the sole discretion of the recipient. This material does not contain sufficient information to support an investment decision.
All investment involves risk , including the loss of capital. The value of investments and the income from them can fluctuate and investors may not get back the amount originally invested.