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Euro Out of Gas - Global Exchanges

FICC Podcasts 13 octobre 2021
FICC Podcasts 13 octobre 2021


Disponible en anglais seulement

In this week's episode, we talk about the meteoric rise in natural gas prices in Europe, and what that should mean for the Euro.


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About Global Exchanges

BMO’s FX Strategists, Greg Anderson and Stephen Gallo, offer perspectives from strategy, sales and trading on the foreign exchange market, related financial markets, and the global economy.

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Disponible en anglais seulement

Greg Anderson:

Hi. Welcome to episode 21 of Global Exchanges, a podcast about foreign exchange markets and related issues. I'm Greg Anderson. In this week's episode, my co-host, Stephen Gallo, and I will be talking about the meteoric rise in natural gas prices in Europe and what that should mean for the Euro. The title for this episode is Euro Out of Gas.

Stephen Gallo:

Hi, I'm Stephen Gallo, a London-based FX strategist. Welcome to Global Exchanges, presented by BMO Capital Markets.

Greg Anderson:

Hi, I'm Greg Anderson, a New York-based FX strategist. I'm Stephen's cohost.

Stephen Gallo:

In each weekly podcast like today's, we discuss our perspectives on the global economy and the foreign exchange market. We also bring in guests from the FX industry and from related financial markets like commodities.

Greg Anderson:

We strive to make this show as interactive as possible. So don't hesitate to reach out by going to BMOCM.com/Global Exchanges. Thanks for joining us.

Speaker 3:

The views expressed here are those of the participants and not those of BMO Capital Markets, its affiliates or subsidiaries.

Stephen Gallo:

Thanks for the intro, Greg. And for the record, it's October 13th, and in the FX markets quarter-to-date so far, although it's still quite early, we've seen a very clear divergence between energy-importing currencies, which have underperformed, and net energy-exporting currencies, which have clearly outperformed. At the bottom of the list in G10 are the Euro and the Yen.

Greg Anderson:

Thanks for describing the picture of FX price movement, Stephen. Is there any other image in your mind that really stands out right now?

Stephen Gallo:

Yes, I do have an image in my head, Greg, and it's the image of Russian President Vladimir Putin taking questions from reporters at the start of Russian Energy Week in Moscow today. Given how much natural gas prices have soared this year, I'm thinking there's got to be a degree of irony in this picture. Tell us, Greg, why is Putin smiling?

Greg Anderson:

I'm pretty sure Putin is smiling because of the evolution of energy prices, particularly natural gas. To get this rolling, let's start by introducing a Bloomberg ticker code. The code is TTF GDAHD. That code is the price of natural gas for delivery in the Netherlands one day ahead. The price is admittedly in funky units because it is expressed in Euros per megawatt hour, with an underlying assumption on the volume of gas needed to produce a unit of electricity. So for those who can't pull up TTF GDAHD, Stephen, can you tell us what that price has done so far in 2021?

Stephen Gallo:

I certainly can. Basically, the price has gone from 20 Euros per megawatt hour in April to 90 Euros today. About 50% of that move, it looks like, has occurred in the last month and a half, just eyeballing it using the chart. But Greg, for the benefit of our listeners, because there is seasonality in the price of natural gas, can you take a stab at making an adjustment for where prices are today relative to what the normal price would be for this time of year?

Greg Anderson:

You're right about the seasonality. Spot gas prices tend to rise in the fall, stay high in the winter, and then drop in the spring. For my seasonal adjustment, I've looked at average price of Dutch delivery gas for the ten-year period from 2011 to 2020. Over that period, the average was rounded to 19 and a half Euros, with a high of 26 Euros and a low of 11. Today's price of, call it 91 Euros, is four and a half times the "normal price" and three and a half times the high of the previous 10 years.

Stephen Gallo:

Right, Greg. So that doesn't sound like a good thing for the European economy. But before we dive into the effects of the crisis on the European economy and the Euro, I think it would be useful to try and dissect how we got to this spot in the first place.

Stephen Gallo:

From my perspective, the underlying issue here is policy-related. It's policy, and therefore that means it's structural in nature. Certainly there are short-term transitory factors involved, like poor weather, low gas reserves related to a cold spring, the post-COVID spike in demand. All of those factors are in play here, but if you do a condensed sweep of the policy backdrop, you can also see, I think, that there are a lot of longer-term factors involved too. Just to name a few of them: the phasing out of coal power plants, Germany's decision to shift away from nuclear power, the accelerated EU-wide push for the transition to renewable energy. That has placed a lot of strain on European natural gas supplies. It's also put additional strain on Europe's electrical grids, EU-wide carbon taxes under the emissions trading system, Nord Stream and Nord Stream 2, which are highly intertwined with Europe's dependence on Russian natural gas exports.

Stephen Gallo:

I think. Greg, that last point, the dependence on Russian natural gas exports, that is the icing on the cake, so to speak. I think it's the icing on the cake for two important reasons. One, because the EU is going to be competing with a lot of other economies for natural gas and LNG supplies in the months and quarters ahead, and that list includes China. And two, because the EU has made it so clear how rapidly it wants to transition to renewables. There isn't a lot of incentive for suppliers like Russia to invest in more capacity. That is why I think this is a very long-term story, not just the 2021 story.

Greg Anderson:

Right, Stephen, sounds ominous and not just for the short-term. Since we're ultimately going to circle back to foreign exchange, and FX is always the comparison of two situations for any given fundamental, I think it is useful to contrast what is happening with European natural gas to what is happening in US. For the US, the benchmark Bloomberg ticker code is simply NG1, which is the NYMEX front future price for natural gas to be delivered in Louisiana, near the mouth of the Mississippi River.

Greg Anderson:

For US gas, today's price is roughly twice the 10-year average for the 13th of October. The price has roughly doubled since April. Just to summarize the comparison, the natural gas shock to the European economy is about twice the size of the natural gas shock to the US economy. That's the comparative we're dealing with here.

Stephen Gallo:

That's a very useful comparison, Greg, particularly as we move to discussing the economic and FX market impact of the crisis. Europe always astounds me because of the very high number of moving parts involved in the picture, particularly because you have this confluence of national and supernational laws and policies. It's complex, to put it lightly. But in terms of the economic and currency impact, I think we can conclude, pretty decisively at this stage, that this is a bearish development, which works through a few different channels.

Stephen Gallo:

The first channel, I think, is it's a tax on economic growth because of the effect on corporate profit margins and, quite possibly, pass-through to consumers and maybe even household sentiment about economic prospects.

Stephen Gallo:

The second channel, I think, is the balance of payments, and the worry here is not only that the situation we've been discussing reduces the trade surpluses. The follow-up question to that is what if smaller trade surpluses trigger additional forms of EU trade protectionism? I raise that question because higher input costs affect the relative competitiveness of EU firms. At the end of the day, the fundamental issue here is one of energy security.

Stephen Gallo:

The third channel that this works bearishly through, I think, is ECB policy. For the time being, the approach of the ECB has been to signal a willingness to look through the inflation overshoot and concentrate on the hit to economic growth. I think part of the story here is that there is still a lot of debt issuance that the ECB needs to soak up in 2022. The Central Bank always seems to be biased towards keeping Euro area credit spreads narrow.

Stephen Gallo:

I think those are the three channels this works bearishly through. The one caveat though to this dovish ECB view that we're talking about is if the Euro weakens materially from here, and the ECB is forced to dial up its hawkishness. I'm not sure how it does this smoothly, given how comfortable the bond market has become with ECB support. But there's definitely something in the notion that a much weaker Euro could lead to more re-steepening of European yield curves.

Greg Anderson:

Just coming back to compare and contrast the Euro-zone with the US, so we can talk about Europe's primary exchange rate, Eurodollar, you call the nat gas price spike something akin to a tax that impacts businesses that use natural gas to power factories or heat stores or, alternatively, tax on consumption by households.

Greg Anderson:

The US's tax increase is only about half the size of the tax increase in Europe. When we get to the balance of payments, the US produces its own natural gas and is, in fact, a slight net exporter, I guess, for now. We'll have to see about five years from now when all of the US wells have been depleted. But anyway, for now, while New Yorkers might not be happy about paying more for natural gas to heat their apartments and businesses, the money goes to Texas, so to speak. It stays inside the same economy in the same currency.

Greg Anderson:

The last issue you pointed out, central bank policy, I would just say that the extent that rising energy prices bring forward rate hikes, that is far more likely to be the case for the Fed than for the ECB.

Greg Anderson:

In summary, any way you slice it, it would appear that this evolution of natural gas prices over the past six weeks should be a negative for Eurodollar. I guess the question we have to ask ourselves is this: Eurodollar has moved from, let's call it 118 and a half to 115 and a half while this energy crisis has unfolded. Has the Eurodollar decline been big enough, or should we expect a further adjustment lower?

Stephen Gallo:

I don't know, Greg, that we should take it as a given that there'll be another leg lower in Eurodollar, but that is how I think the current balance of risk is skewed for the currency pair, definitely lower for the time being, if for no other reason than the fact that it's difficult to see how policy makers globally will be able to engineer a completely smooth landing, without any bumps in the road. That's, of course, in addition to the Euro area's fundamental backdrop. So I pass it back to you, Greg. Is there anything we're missing in this picture?

Greg Anderson:

I think maybe the only thing we might be missing is positioning.

Stephen Gallo:

You mean the fact that investors are already short Euros?

Greg Anderson:

Yes, Stephen. I would characterize the Euro short position now as pretty darn big, having grown from small short in August when this whole saga began. Basically, what FX investors have done is they have anticipated the balance of payment impact on Euro and sold it in advance. If something happens that forces them out of those positions before balance of payment effect is realized, then we could get some funky Euro bounce that doesn't make a lot of sense otherwise.

Stephen Gallo:

That's perfect. Greg. I think this is a great way to end the podcast. Basically. I think it's going to be an interesting winter. I'll leave it at that. Thank you, listeners, for joining us again. That's a wrap. Until next time.

Greg Anderson:

Thanks for listening to Global Exchanges. Listen to past episodes and find transcripts at BMOCM.com/GlobalExchanges.

Stephen Gallo:

We'd love to hear what you thought of today's episode. You can send us an email or reach out to us on Bloomberg. You can listen to this show and subscribe on Apple podcasts, Spotify, or your favorite podcast provider.

Greg Anderson:

This show and resources are supported by our team here at BMO, including the FICC Macro Strategy Group and BMO's marketing team. This show is produced and edited by Puddle Creative.

Speaker 3:

This podcast has been prepared with the assistance of employees of Bank of Montreal, BMO Nesbitt Burns, Inc, and BMO Capital Markets Corporation together, BMO who are involved in fixed income and foreign exchange sales and marketing efforts. Accordingly, it should be considered to be a product of the fixed income and foreign exchange businesses generally, and not a research report that reflects the views of disinterested research analysts.

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Greg Anderson Chef mondial, Stratégie de change
Stephen Gallo Chef de la stratégie de change pour l’Europe

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