As we while away the warm – even hot – summer months in the Grand Duchy, it’s on many people’s minds that winter is on its way. And that means we go back to burning gas. While official sources show that Luxembourg doesn’t import much Russian gas, we all pay the going market rate.
This is what may be on the mind of analysts like Dr Volker Schmidt, a senior portfolio manager at Ethenea Independent Investors SA. In a recent press release, he explained his views on the impact that gas could have in throttling the economy. as well as how inflation and interest rates will develop, and whether a recession is imminent.
Schmidt expressed surprise at the IMF’s recent forecast predicting Eurozone growth slightly exceeding the American version in both 2022 and 2023. He based his reaction on the fact that the Eurozone imports a high proportion of its gas consumption. He said that the eurozone forecast is “certainly on shakier ground,” given the omnipresent risk of Russia suspending delivery. This is why his employer prefers the US dollar over the euro, despite them being close to parity.
Recession risk
The risk of a recession is a subject dominating conversations about the economy. But, said Schmidt this is somewhat surprising given that the US economy has created over 400,000 new jobs per month recently. The situation in the Eurozone is similar.
“Even if the US economy were to fall into a technical recession, with two quarters in a row of negative growth” Schmidt said, “we still expect a robust labour market in 2023. A hard landing with an unemployment rate of over 5% could only follow the next year – 2024.” But Schmidt said that this is “hardly relevant for the financial markets at the moment.”
Gas prices push up inflation
Another important issue for investors is the influence of gas prices on inflation, explained Schmidt.
“Here, too, the Eurozone and the USA are not far apart with inflation rates that are currently around 9 percent,” said the portfolio manager. “The dramatic increase of the inflation rate started earlier in the US and has now become much more widespread.” Schmidt contrasted this with the increase in the Eurozone, which started later and was “was very much due to high energy prices.”
The IMF predicts a faster slowdown in the US, with inflation at 3% in 2023, while the Eurozone should still be as high as 3.9%, he explained.
“The yield curves for US Treasuries and German government bonds reflect this to some extent. The US curve is already clearly inverted with 2-year yields well above 10-year yields, whereas the German yield curve continues to have a classic upward shape,” Schmidt said.
Further along
Given its earlier experience with the inflation surge, the US Federal Reserve is already further along with its interest rate hikes, explained Schmidt. No interest rate cuts are expected until the end of 2023. The ECB, however, has only just started raising rates.
“If the IMF forecast is confirmed and gas deliveries from Russia remain relatively stable, then the ECB would only think about interest rate cuts again after the Fed,” said Schmidt.
He explained that this fact explains why his employer sees yields on 10-year Bunds of under 1% “are clearly too low in our view.” He said that investors who agree with him that have still to start believing in a significant Eurozone recession should keep an eye on the price development of those instruments, “because prices could fall again and yields could rise.”
Energy firms a risky proposition
Ethenea pointed out last spring that investments in energy firms bear high risks. He mentioned Electricité de France (EDF), which might be nationalised and Germany’s Uniper, which that government may have to rescue.. Bond and promissory note creditors will get their money back, but, he said: “Our caution was certainly correct.” EDF shareholders will get another attractive price for their investment under nationalisation, but Uniper investors will have to digest a high loss, he said.