Christopher Dembik

Right before the ECB decision, we asked Christopher Dembik from Saxo Bank why does ECB consider expected by markets 25bp hike. Christopher Dembik (Saxo Bank): Basically this is a compromise between the hawks and the doves among the GC. Inflation is receding but not as fast as expected while credit data point out to slower growth in the coming quarters - we are however very far from a recession in the EZ. Expect the ECB to keep increasing rates at the short-term, at least until the summer. (...) we are however very far from a recession in the EZ Read next: Indeed, as shown in the graph below, Bitcoin’s Q1 2023 ROI outperforms 5 major indexes’ average ROI by 170% | FXMAG.COM

Eurozone inflation and next European Central Bank decisions are arousing interest as it's not obvious what's going to be. Christopher Dembik (Head of Macro Analysis at Saxo Bank) shares his thoughts on the interest rate with us. Provided Eurozone inflation comes at less than 10% on Wednesday, would you expect ECB to go for a series of 25bp rate hikes? Christopher Dembik (Saxo Bank): I think a 50 bp interest rate hike is still the best case for the February meeting. Actually, I expect at two more 50 bp hike in the coming months followed by a 25 bp in May. Then the ECB might be eager to pause. But I don't see any urgent need to lower the scope of the interest rate hike. The slowdown in inflation is actually not sharp enough. Read next: Matt Weller (City Index): Even if inflation continues to moderate, Madame Lagarde and company are likely to opt for at least one 50bps rate hike to start the year| FXMAG.COM We also share Saxo Asia view on ECB: ECB's dovish surprise likely as inflation slows The ECB is considering a slower pace of rate hikes than Christine Lagarde indicated in December. While a 50bps increase next month remains the most likely outcome, a 25bps move in March is gaining support. Inflation in the Eurozone is slowing, and a sharp drop in natural gas prices suggest that we can continue to expect lower inflation in the months to come atleast until the 2023 winter risks emerge. The final CPI print for December for the Euro-are will be released today and ECB's minutes of the December meeting are due tomorrow.

Summary:  The Czech Presidency of the Council of the European Union (EU) announced an emergency energy meeting will be held on 9 September in Brussels (Belgium). This aims to discuss concrete measures to tackle the energy crisis while power prices continue to reach record high. Last week, France 1-year forward electricity prices crossed for the first time ever the level of €1,000 per megawatt-hour (MWh). Before the crisis, anything above €75-100 per MWh was considered as expensive. Three main options are on the table : targeted compensatory measures for low-income households, applying the ‘Iberian exception’ to the entire EU (temporarily decoupling the price of gas from that of electricity) and reforming more fundamentally the European electricity market. There is no easy answer. Each of these options has downfalls. In our view, the energy crisis is here to stay. The world of cheap energy is over. We have entered into a brave new world of high inflation and high energy prices. An unbearable cost : According to the calculations of the Brussels-based think-tank Bruegel, EU governments have allocated almost €280bn to help companies and households to cope with higher energy bills since September 2021. In nominal terms, the largest European economies allocated the most funding (Germany €66bn, Italy €49bn and France €44bn). In percentage of GDP (which is a better way to compare), the financial cushion deployed is the largest in Greece (3.7 %), Lithuania (3.6 %) and Italy (2.8 %). This cannot last forever. Several countries are looking to reduce financial support. They want to implement a targeted approach to mostly help low-income households. In France, the government capped energy prices in 2022 (gas prices were frozen at the levels of Autumn 2021 and electricity prices increased only by 4 % this year for households). But this is costly (around €20bn – this is about half of the annual budget of the French ministry of Education). Based on current energy prices, expect the cost to be close to €40bn for this year. In light of higher interest rates and risks that massive financial stimulus further fuels inflation, we believe that many European governments will follow the pace of the French’s. They will decide to downsize the financial package aimed to cushion the energy crisis. On top of that, several EU countries are embattled with the need to bailout utilities at risk of insolvency (Germany’s Uniper and two Vienna municipal utilities, for instance). This is only unfolding now. Electricity market intervention is back on the agenda : Yesterday, the president of the European Commission (EC), Ursula Gertrud von der Leyen acknowledged the EU electricity market is no longer functioning. This is an understatement. There are mostly two options on the table. Both will be discussed at the upcoming emergency meeting of 9 September. The first option is to propose that the entire EU apply the ‘Iberian exception’ to set electricity prices. In mid-April 2022, the EC agreed that Spain and Portugal create a temporary mechanism to decouple the price of gas from that of electricity for a period of 12 months. Concretely, the price of gas was capped to an average of €50 per megawatt-hour. This resulted in electricity bills being halved for about 40 % of Spanish and Portuguese consumers with regulated rates. This could be applied at the EU scale. This is supported by Germany, Austria, Belgium, Spain and Portugal especially. However, this is far from being perfect. It led to significant leakage – basically a surge in power exports to France. In other words, a lot of the subsidy actually ends up in France. In addition, prices continue to increase at a speedy rate for 60 % of consumers. The second option is to separate the wholesale power market into two segments : a mandatory pool for low-variable cost technologies (wind, solar, nuclear, for instance) and a conventional market for fossil condensing plants. This proposal is pushed forward by Greece. This is a more fundamental reform of the EU electricity market. But there are several downsides, especially regarding how existing long-term contracts will be treated. Much more emergency meetings will be required before a coherent approach will be approved. Don’t expect major decisions to be announced next week. The nuclear option : In our view, the European energy crisis is an opportunity to rethink policy stance on nuclear power. Last week, several non-partisan organizations launched a petition to prevent Switzerland from leaving nuclear power in 2027, as scheduled. This decision was initially taken in the aftermath of the 2011 Fukushima crisis (Japan). According to the July data from the World Nuclear Association, France and the United Kingdom are the two main European countries with the most nuclear capacity under construction. But others don’t seem to embrace this option. In Germany, the Greens prefer to restart coal-fired power stations rather than rethinking the nuclear exit plan. This is puzzling. Nuclear power is not without issues (see corrosion issues in France nuclear reactors). But it guarantees energy independence and lower energy prices in the long-run. While Asia is embracing nuclear power (South Korea is reversing nuclear phaseout and China is accelerating its huge buildout in reactors, for instance), we fear that the EU will still be reluctant to bet on nuclear for ideological reasons. Like it or not, nuclear energy is our best option at the moment to reduce dependence on expensive fossil energy and move forward fast with the green transition. On the spot side, electricity prices continue to remain close to record high in France and Germany, respectively at 641 and 604€ per MWh. In contrast, they remain comparatively low in Spain and Portugal, around 200€ per MWh. This is roughly 10 times more than before the Covid, however. Source: EU Emergency Energy Meeting : A Never Ending Story

Summary:  France is well-known for his strong resilience on nuclear energy (about 69 % of electricity generation). But France’s forward energy prices are currently higher than those of any other major European economies (Germany, for instance). This is puzzling. In today’s ‘Macro Chartmania’, we explain the current state of France’s electricity crisis, why the worst is yet to come and why it may last for more than a single winter. We also discuss the monetary policy implications of elevated energy prices in France and in the rest of the eurozone, in light of European Central Bank (ECB) Board Member Isabel Schnabel’s speech at Jackson Hole last week. Click here to download this week's full edition of Macro Chartmania composed of more than 100 charts to track the latest macroeconomic and market developments. All the data are collected from Macrobond and updated each week. France’s electricity prices are close to record highs. The baseload power price is above €900 per MWh – see below chart. Many other European countries face similar prices (Germany, Belgium, Italy, for instance). But tensions are higher in France. The French-1 year electricity forward is at the highest level among major developed European economies. Last Friday, it jumped to a historical record of €1,000 per MWh (versus €900 per MWh for Germany). This represents an increase of +1000 % compared with the long-term average of 2010-2020. This is also a clear signal that traders don’t expect prices to get back to normal anytime soon. Contrary to other European countries, France’s energy crisis has little to do with the Ukraine war and the European sanctions against Russian gas. This is mostly due to corrosion issues in nuclear reactors (this caused the shutdown of about half of France's fifty-six nuclear reactors.) and low water levels related to unusual heat during the summer (three nuclear reactors were shut down temporarily because of climate conditions this month). The country is highly dependent on nuclear energy. This represents about 69 % of electricity generation (this is a larger share than any other country). About 17 % of nuclear electricity is produced thanks to recycled materials. Summer heat will likely stop soon. But corrosion issues are partially structural and here to stay. In a statement a few months ago, the French nuclear energy regulator ASN mentioned that a restart of nuclear reactors closed due to corrosion could take up to several years. The risk of electricity shortage is therefore real this winter (no matter how the weather conditions are, actually). During the summer, electricity demand is around 45 GWh. During the winter, higher consumption will push electricity demand around 80-90 GWh on average. This will put under tension all France's electricity infrastructure, thus increasing the risk of a shortage. We think that France is certainly in a worse position than Germany when it comes to energy supply (at least, in the short-term). So far, the French government has mitigated the energy crisis by capping electricity and gas prices for households (gas prices were frozen at Autumn 2021’s levels and electricity price increase was capped at +4 % this year). This does not apply to corporations, however. This cannot last forever. The cap on energy prices will expire at the end of the year for gas and in February 2023 for electricity. The government is not planning to extend it further. It is too costly (about €20bn so far this year on a total of €44bn of various measures to support companies and households facing high inflation. This represents the total annual budget for education in France). From 2023, more targeted measures to help the low-income households to cope with higher energy prices is the most likely scenario. Will it be enough ? This is far from certain. A repeat of the 2018 Yellow Vest Movement (meaning massive demonstrations against the cost of living) is not out of the table, in our view. Eurozone monetary policy implications France is not the only European country in a very uncomfortable position, at the moment. The situation is worse than in its counterparts. But all the continent is facing the prospect of a difficult winter due to persistent high inflation. Contrary to the United States, we think the peak in eurozone inflation is ahead of us. The explosion of power prices is one of the three factors (along with a weak euro exchange rate and the easing of government measures to cap prices from 2023 onwards) which make us consider that inflation will remain elevated for a prolonged period in the eurozone. In terms of monetary policy, this means the ECB is likely to be more aggressive in the short term before potentially reviewing its policy stance if the recession materializes. The ECB Board Member Schnabel was very clear about it at last week’s Jackson Hole Symposium. In her speech, she argued that three arguments of why central banks should act with determination : 1) inflation uncertainty (there is no way to predict accurately the evolution of energy prices in such a volatile environment, for instance) ; 2) credibility ; and 3) the cost of acting too late (in some respect, the ECB certainly waited for too long between the February policy pivot and the July interest rate hike). In the short-term, this means there will be more weight on realized data (especially the preliminary release on Wednesday of the August eurozone CPI expected at a new record high of 9 % year-over-year). This increases the probability of a significant move of 75 basis points at the next Governing Council of 8 September.   Source: Chart of the Week : The energy crisis is hitting France

Summary:  In today’s ‘Macro Chartmania’, we give an update on the German economy. Back in 2019, we wrote that the German economy was structurally doomed to decelerate due to China’s slowdown and severe underinvestment in the ICT (Information and Communication Technology) sector. This was before the 2020 pandemic outbreak and the 2022 energy crisis. Now, there is little doubt that Germany will enter into a recession this year. It is facing a perfect storm : high inflation for a prolonged period, failure of the multi-decade model growth based on cheap Russian energy and massive imbalance in R&D investment. This is not to say that Germany will become Europe’s new sick man. The country has everything in hand to overcome these challenges. But, in the short-term, it is without doubt a tough time for Germany and thus for the rest of the eurozone. Click here to download this week's full edition of Macro Chartmania composed of more than 100 charts to track the latest macroeconomic and market developments. All the data are collected from Macrobond and updated each week. The below chart partially explains why the German economy is not out of the woods anytime soon. So far, the country has avoided entering into a technical recession. This is explained by a rebound in external demand reflecting improved export growth to Turkey and a stabilization in export growth to the United Kingdom - two key trade partners. However, a recession is certainly only a matter of time. On Monday, the Bundesbank acknowledged that a recession is likely this year. The weak economic momentum in China is a source of concern. China is Germany’s most important trading partner with an average total trade volume in recent years of around €200bn. The latest data show that Germany export growth to China is close to its lowest level since the pandemic outbreak, at minus 8.3 % year-over-year in July. Based on preliminary trade data, the recent stabilization we can see in the below chart is likely to continue. But China’s weak growth is not Germany’s only problem. Inflation is here to stay. The Bundesbank forecasts it will peak around 10 % in the coming months versus 8.5 % year-over-year in July. This is likely. Contrary to the United States, the peak in eurozone inflation is ahead of us. Even if we pass the peak, inflation will remain elevated for long due to higher energy prices (lower reliance on Russian gas and oil will take years to materialize), weak euro exchange rate (a drop of the EUR/USD cross to 0.96 by year-end is highly possible) and the easing of government measures to cap prices (eurozone inflation is actually now artificially low). On top of that, Germany is also facing a structural challenge due to misallocation of investment. This is nothing new. But this is becoming an accurate problem nowadays as the economy is showing worrying signs of weakness. Looking at the global level, Germany is well-ranked in terms of R&D investment. Here comes the issue. A big chunk of it is attributable to the struggling automotive sector. It represents more than 50 % of total R&D investment over the recent years against only 6 % in the United States, for instance. The automotive sector is now in disarray. Supply chain disruptions, weaker demand and high energy bills are hurting carmakers. In the latest ZEW report for August 2022, the current conditions subindex for the car industry was out at minus 44.1. This is a better reading than a few months ago. It fell at minus 61.7 in April 2022 on the back of the Ukraine war, for instance. This is still close to its lowest annual levels, however. The oversized share of R&D investment coming from the car industry has an immediate negative impact : the ICT sector suffers from chronic underinvestment. This negatively impacts potential growth and leadership in key technological innovation. The pandemic outbreak and the following lockdowns showed that Germany is lagging behind in digitalization notably. Germany’s economy is now at a crossroads. For years, policymakers avoided tackling the issue of overdependence on cheap Russian energy (which was a key factor behind German industry’s high competitiveness) and massive imbalance in R&D investment. Hopefully, the upcoming recession will help to move forward on these two issues. There is no other choice but to find new energy alternatives.  The process has already started. This is also urgent to reduce economic dependence on the car industry and channel R&D investment in other sectors. This has yet to happen. In the meantime, if Germany sinks into a recession, expect the eurozone to follow immediately after.     Source: Chart of the Week : Weak Germany

Summary:  Every day, we get asked, about “‘Recession or no recession?’”. It is not a binary trade situation where recession is bad, and no recession is a green light for risk. Every day, we get asked, ‘Recession or no recession?’ It is not a binary situation where recession is bad and no recession is a green light for risk. We are going to be in much lower growth, especially in 2023, than many had expected, whether there’s technically a recession or not. The material growth slowdown is visible in all the recent statistics. The eurozone is certainly in a worse position than the United States or China. Eurozone policymakers, especially the dovish majority of the European Central Bank (ECB) Governing Council, took too long to acknowledge that inflation is not as transitory as earlier thought. I remember the short but instructive discussion I had with the central bank governor of a ‘small’ eurozone country in October 2021. At that time, we been warning our clients for months that high inflation is here to stay. This wise governor agreed that there was growing evidence that inflation won’t disappear, and that the central scenario of the ECB staff was too optimistic. But he belongs to a minority in the Council and had little leverage to push the rest of the Council in the right direction. Several months later, I think there is now a broad consensus that inflation will remain a headache for years to come.   Inflation is structural  The main issue is inflation on the supply side. This refers to inputs to production (labour, fuels, commodities like agriculture and electricity), operations and transport. Operations can be shocked and resumed quite fast. We experienced it in Europe during the pandemic. Transport can be shocked due to a strike, blockages or a lack of containers (which is a major issue nowadays) too. But this can be resolved with time. We expect the arrival of new containers from 2023 onwards will help ease transportation bottlenecks. All of these can be considered as transitory. But the supply shock affecting inputs to production is certainly much more permanent.  Let’s look at commodities. Despite all the communication around green transition, Europe is still very dependent on fossil fuels (oil, natural gas and coal). Because of the war in Ukraine, we are shocking the Russian supply of fossil fuel—the very thing we use. With demand rising and supply shocked, prices rise—this is basic economics. We would logically expect investment to jump to crush prices. But there are two issues. First, we don’t consume crude oil but rather the refined part of it. There is an entire infrastructure built to refine Russian oil in Europe, but we cannot use it anymore. We need to replace it, but it will take years to build an entire new infrastructure. In the meantime, costs will continue to increase. Second, the European Union is imposing regulations for the green transition from fossil fuel. Europe has always acted by regulating things. But green transition regulation has diverted needed investment in fossil fuel infrastructures to renewable energy, without making sure that green energy can provide a constant supply of energy to Europeans. At the end of the day, this means higher energy costs for years to come. Inflation is structural. However, there is another factor which is inflationary to some extent—fiscal policy. European governments have unveiled emergency measures to address inflation—for instance, value-added tax (VAT) reduction on energy and extension of the benefit of the ‘social tariff’ on electricity and natural gas for the poorest households in Belgium, and increasing the minimum wage to €12 per hour from next October and an additional aid of €100 for the poorest households in Germany. With the fiscal potential in Europe far greater than many other places, expect these one-shot measures to become more permanent and for other subsidies to come soon.  When risk becomes reality  Economic history has taught us that the only way to lower inflation is to hike interest rates. Many other central banks have done it since the exit of the last global lockdown in spring 2021. After a long period of hesitation, the ECB is finally going with the crowd. They will hike interest rates at the July meeting by 25 basis points (a ‘gradual’ tightening)—the first since 2011. It would be too easy if the ECB could normalise monetary policy by only focusing on inflation and growth. However, there is another issue to tackle that’s as important as high inflation—financial fragmentation.  Bond market volatility is picking up everywhere, mostly due to the big global inflation shock that is hitting everyone. But the deterioration is faster in the eurozone. The repricing of risk in a world without quantitative easing (QE) is painful. The ECB Systemic Risk Indicator (developed in 2012 and based on 15 financial stress measures) is back to levels not seen since the outbreak in March 2020 (see chart 1). The repricing is more painful for some countries than others. Since the end of QE, Italy’s borrowing costs have jumped higher. The 10-year bond yield is now nearly three times as high as in early February. The spread vis-à-vis Germany has risen too and is back in risk territory (see chart 2). What is most worrying is not the level of bond yields but the process. Volatility is picking up too quickly and liquidity conditions are deteriorating fast at the same time. Basically, foreigners just want to get out of the Italian bond market (see chart 3). There is no doubt the ECB will announce a new tool to manage sovereign spreads soon, perhaps as early as the July meeting. We don’t have many details at the moment. Based on Isabel Schnabel’s recent comments, we can assume it will be some kind of Outright Monetary Transactions programme with light conditionality, for a temporary period of time and with shorter maturities than the Pandemic Emergency Purchase Programme (perhaps between two to five years). It should be enough to avoid a repeat of the 2012 crisis, but this is far from certain. The ECB cannot refrain from raising interest rates. The more they do, the more that breaks and the more they will have to buy eurozone government bonds. From an optimistic viewpoint, a eurozone crisis redux is not all negative. From 2012 onwards, the previous crisis helped to bring about crucial institutional reforms that strengthened the eurozone framework. The same could happen again in case of a new crisis. However, the eurozone bond market situation raises a serious question in the long run: Can this go on forever ? At some point, the southern eurozone countries should be able to face the markets without the ECB stretching its mandate to rescue them. Otherwise, the ECB could end up owing the entire Italian debt.  Explore products at Saxo Source: Towards an eurozone crisis redux – Outlook Q3 | Saxo Group (home.saxo)

Summary:  The European Central Bank (ECB) confirmed they will hike interest rates at the July meeting by 25 basis points. This is a done-deal. Uncertainty remains regarding the scope of the hiking cycle after the summer. This will depend mostly from the evolution of the HICP and inflation expectations. The eurozone is likely to exit the era of negative rates (this was economic nonsense) by the end of Q3 this year. We think the hiking cycle could be shorter with fewer hikes than the money market expects, especially if growth continues to slowdown in the second part of the year. The risk of recession is low this year. But the eurozone is undoubtedly facing economic stagnation. What was announced « It’s not just a step. It’s a journey » - ECB President Christine Lagarde We are a bit puzzled by today’s ECB meeting. The ECB clearly confirmed they will hike rates by 25 basis points at the July meeting. This is the first time in memory that a G10 central bank explicitly tells us the amount they intend to hike at the next meeting. Fed President Jerome Powell hinted at a 50 basis points interest hike in June, for instance. But it was not presented as a done-deal. He kept some optionality. This is surprising the ECB decided to tie their hands, for no real gain. The ECB is more uncertain regarding the September meeting. Lagarde said they could move by 50 basis points, depending on the inflation backdrop. Beyond September, the ECB appears committed to a gradual rate path – a less hawkish outlook taking into consideration the risk of lower growth (especially if the cost of living continues to rise, thus pushing consumption down. Real incomes are expected to drop in most eurozone countries this year, according to the OECD, sometimes quite sharply, like in Greece with a drop of 7 %). We don’t comment much on the new ECB staff forecasts. The inflation forecasts for this year are already outdated. Forecasts for 2023 and 2024 will likely be revised upward for inflation and downward for GDP growth by year-end. This is certainly the right moment to be humble and acknowledge that inflation is so sticky that we are unable to forecast it even for the next three months. What is missing The ECB is here to close spreads – see below chart The ECB wrongly believed that by going with the safe option of a 25 basis points interest hike in July, the Italian bond market would give them a break. It hasn’t happened that way, unfortunately. Immediately after the press conference, the core/periphery spread widened significantly. Italy’s 10-year government yield was 23 basis points higher. The gap between the German and the Italian 10-year government bond yields widened further (220 basis points). We are back in the danger zone. But this is no time to panic yet. We are still far from levels which would trigger a market intervention. However, we believe that the ECB will have no other choice but to provide news about an anti-fragmentation facility at the July meeting. No doing so would push spreads higher at the worst time ever, when volumes are getting dangerously lower. This anti-fragmentation facility is a must-have for the ECB in order to speed up the tightening process if needed (that’s why the idea is supported by hawks) and to avoid a repeat of the 2012 sovereign debt crisis. However, this won’t be easy. Designing such a weapon is complex. All the pre-existing solutions (Securities Market Programme and Outright Monetary Transactions) come with major political and technical drawbacks. We think the easiest option would be to implement some kind of OMT 2.0 with soft conditionality. But further discussions are needed. This would ideally come on top of the €200bn of firepower coming from bringing forward PEPP reinvestments by one year (referring to the Pandemic Emergency Purchase Programme launched at the start of the outbreak in March 2020). Though this amount is significant, this is only a first line of defense. It would do too little to avoid financial fragmentation within the eurozone if this happens. In many regards, the design and the implementation of an anti-fragmentation facility is much more important for the future of the eurozone than the short-term pace of interest rates. What’s next Inflation expectations will be the key driver from September onwards ·       The first estimate of the June eurozone HICP will be on 1 July. In May, it reached a new high of 3.8 % year-over-year (with core goods at 4.2 % and services at 3.5 %). This is uncomfortably high. A new jump would increase pressure in favor of a 50 basis points move in September. ·       From September onwards, expect that market-based and survey-based inflation expectations (SPF) will be the main drivers of policy normalisation. At today’s conference, Lagarde mentioned « initial signs » of inflation expectations getting de-anchored. This draws a lot of market expectations. But the central bank’s hawkishness might vanish fast if GDP growth continues to slow down. The ECB will navigate in a very complicated economic environment from Q3 onwards – lower investment, gloomy consumption and inflation well-above the target for longer. Expect tough discussions between hawks and doves within the Governing council and a more uncertain pace of monetary policy normalisation. ·       Expect the eurozone to exit negative rates by the end of Q3 this year. The era of negative rates was a costly anomaly for the financial sector. This is positive news. We are getting back to normal. But we think the market is probably over-estimating the pace of monetary policy tightening in the medium-term in the eurozone. We think that lower growth could push the ECB to slow the hiking cycle sooner than expected. Source: ECB A clear roadmap for the summer holiday more uncertainty from September onwards | Saxo Group (home.saxo)

Summary:  In today’s ‘Macro Chartmania’, we focus on the upcoming European Central Bank (ECB) meeting scheduled for Thursday. All the data are collected from Macrobond and updated each week. Click here to download this week's full edition of Macro Chartmania composed of more than 100 charts to track the latest macroeconomic and market developments. This week’s ECB meeting will open the door to an interest rate hike in July – the first time since 2011. Expect the ECB to announce an end to its bond buying program and that net asset purchases will be completed by the end of the month. This is a necessary step before increasing interest rates. Focus will be on the new ECB staff forecasts. There is no pleasant surprise to expect : a clear downward revision to GDP growth and core inflation above the target longer out are likely. However, the eurozone should avoid entering into recession this year (though a bunch of countries might already be in a technical recession, such as France). GDP forecasts will certainly be revised downward once more before the end of the year. Therefore, don’t over-interpret the new forecasts. The ECB has a track-record of being overly optimistic about growth and its ability to deal with inflation -whether it is too low or too high.   Pay more attention to Christine Lagarde’s press conference. The eurozone CPI topped 8 % year-over-year in May – the highest on record - and the eurozone HICP, which is highly watched by the ECB, reached a new high of 3.8 % in May (with core goods at 4.2 % and services at 3.5 %). This is uncomfortably high. In these conditions, Lagarde has little choice but to deliver an hawkish message this week – meaning higher rates and a stronger euro. The next data to look at closely will be the first estimate of the June eurozone HICP on July 1. ECB hawks might be vocal in favor of a fast tightening pace afterwards. While pressure is undeniably building in favor of a 50 basis point move in July, we doubt the ECB will start its hiking cycle with such a big step. This would be very surprising and inconsistent with Lagarde’s forward guidance (she has recently signaled the ECB’s first moves would take place gradually). We don’t think one data point will make such a difference that the ECB will decide to act stronger in July. A 25 basis point interest hike is a safe and reasonable option, in our view. This has already been priced in the market. This partially explains why downward pressure on the euro exchange rate has eased since mid-May. From September onwards, the ECB is likely to steadily lift the deposit rate – see market forecasts below. For the record, the two last times the ECB hiked interest rates in July, it was just ahead of a recession. But we think the eurozone will avoid it, at least this year. Discussion will be about financial fragmentation this week too. According to the Financial Times, there is a large consensus within the Governing Council to support a facility to manage sovereign spreads – some sort of OMT 2.0 with light conditionality. Italy is still the main point of worry. Foreign investors have tried to exit the Italian bond market since January (this was not the case in any other Southern European country). This will likely accelerate in the coming months, adding more pressure on Italian sovereign yields. Even the hawks are supporting the idea of a facility because they understand well this is a necessary condition if they want to hike interest rates more aggressively. This new facility would come on top of the €200bn of firepower coming from bringing forward PEPP reinvestments by one year (referring to the Pandemic Emergency Purchase Programme launched at the start of the outbreak in March 2020). Though this amount is significant, this is only a first line of defense. It would do too little to avoid financial fragmentation within the eurozone if this happens. We don’t expect the facility to be officially announced this week. The debate is only starting and some technical work needs to be done as well. An official announcement will probably be made after the summer. This will have much more implications for the eurozone than the tightening cycle. It will help create the required safety cushion the union needs to deal with this new period of economic history characterized by higher nominal rates, lower growth and high inflation for longer. Source: Chart of the Week An ECB rate hike is imminent | Saxo Group (home.saxo)

Summary:  In today’s ‘Macro Chartmania’, we focus on the Real Effective Exchange Rate (REER). All the data are collected from Macrobond and updated each week. Click to download this week's full edition of Macro Chartmania composed of more than 100 charts to track the latest macroeconomic and market developments. The below chart shows the Real Effective Exchange Rate (REER) for the euro and the U.S. dollar. This is the weighted average of a country’s currency against a basket of other major currencies. It is used for international comparisons, especially by the International Monetary Fund and the World Bank, for instance. Currently, the U.S. dollar is 27 % too high compared to the euro, based on the REER. The last time the gap was so wide was when the outbreak started in 2020. This is only the beginning, in our view. U.S. dollar net speculative positioning continues to increase at a speedy pace. Several factors are pushing investors to look for the default safe haven : risk of technical recession or stagflation in several developed economies (France, Germany and the United Kingdom, for instance), skyrocketing commodity prices (especially for agricultural goods due to the Ukraine war and the drought in India), equity bear market, lockdowns in China which will push down global GDP growth this year, persistent inflationary pressures (resulting from supply chain disruptions and higher wage compensations, amongst other things) etc. From a technical point of view, the USD is likely to move upward in the short-term. We expect that risk-off waves will push the DXY index well above 105.00. The EUR/USD is likely to remain under pressure too. How long do you think this can go on before something snaps ? My bet : the European Central Bank (ECB) will have no other options but to increase interest rates at the July meeting to bring support to the EUR and close the gap with the U.S. dollar. Timing is everything : the July meeting will take place just one day after the release of the first estimate of the eurozone Q2 GDP. If the Governing Council decides to move forward with a rate hike, this would reduce imported inflation, in theory. The ECB is caught between a rising dollar and a weak euro. This is simply intolerable. Several governing council members, including those considered as the most pragmatic, are now leaning in favor of a rate increase and exiting negative rates by the end of the year (Banque de France’s Villeroy de Galhau, for instance). This will certainly not solve from one day to another inflationary pressures within the eurozone (inflation is partially driven by external forces such as commodity prices). But it will at least reduce the FX-passthrough into inflation which is becoming problematic. Source: Saxo Bank

Summary:  In today’s ‘Macro Chartmania’, we focus on the ECB Systemic Risk Indicator. All the data are collected from Macrobond and updated each week. Click to download this week's full edition of Macro Chartmania composed of more than 100 charts to track the latest macroeconomic and market developments: MacroChartmania_master1402. Risks are tilted to the upside in the eurozone : risk of technical recession in France, risk of stagflation in Germany, persistent supply chain disruptions (due to the zero Covid policy in China and the Ukraine war), commodity supercycle (with higher food and energy prices hitting hard the 15-20% lowest income quintile), low real effective exchange rate leading to higher imported inflation (based on our calculations the EUR is 27 % too low compared to the USD, for instance) and weak European leadership, amongst other things. The situation is unlikely to improve, in the short-term. We see higher risks of financial stress in the eurozone too. We measure the evolution of financial risk using the ECB Systemic Risk Indicator (created in 2012 by Hollo, Kremer and Lo Duca) – see below chart. This is based on fifteen financial stress measures (such as exchange rates and spreads etc.). It now stands at 0.26 and keeps climbing. It is still below the peaks reached in March 2020 at 0.35 (global lockdown) and in February 2022 at 0.34 (invasion of Ukraine by Russia). But we believe it is likely to reach the pain zone of 0.34-0.35 in the coming months and weeks. Foreign investors are getting increasingly worried about the risk of bond market fragmentation in the eurozone. Some countries are in a better position than others. Liquidity in the Italian sovereign bond market has been deteriorating sharply this year. Basically, foreigners just want to get out. This is not the same situation in Spain, for instance. The country is still getting foreign inflows. Wider spreads are putting Italy at risk. We fear the country will become Europe’s black sheep once again – thus putting eurozone policymakers to the test. The Italian long-term bond yields are now 2 percentage points higher than for Germany (which serves as the market benchmark). It will probably get worse when the ECB ends Quantitative Easing and starts hiking interest rates, perhaps as early as at the July meeting. There will be no roaring twenties for the eurozone. Source: Saxo Bank

Summary:  The economist consensus anticipates inflation will start falling from early next year. We disagree. We consider the market to be too complacent regarding upside risks to the inflation outlook. The great awakening of workers and the steady rent increase (for the United States) are two of the factors which are likely to maintain inflation uncomfortably high into 2022, in our view. October CPI figures released earlier this week confirm that inflationary pressures may last longer than initially expected. Inflation reached levels which have not been seen for decades in the United Kingdom (+4.2% YoY), in the eurozone (+4.1% YoY) and in Canada (+4.7% YoY). In Canada, the jump in inflation is the strongest recorded in 18 years. For now, investors are confident. They believe the U.S. Federal Reserve and European Central Bank’s narrative that inflation will start to fall from early next year. This is far from certain, in our view. From supply chain bottlenecks to energy prices, everything suggests that inflationary pressures are far from over. Expect energy prices to continue increasing as temperatures will drop in Europe from next week onwards. This will weigh on November CPI data which will be released next month. The peak in inflation has not been reached. We fear investors are too complacent regarding upside risks to the inflation outlook. Every economic theory says inflation will be above 2% next year : ·         The Phillips curve is alive and well : workers are demanding higher salaries, amongst other advantages and their expectations are rising. ·         Monetarism : the global economy is characterized by large deposits, desire to spend and to convert cash into real assets. ·         Commitment approach : the U.S. Federal Reserve (Fed) and the European Central bank (ECB) have a dovish bias. This is confirmed by their new inflation strategy (symmetric 2% inflation target over the medium term for the ECB and inflation of 2% over the longer run for the Fed). ·         Fiscal approach : high public debt and fiscal dominance (central banks need to remain dominant market players in the bond market to avoid a sharp increase in interest rates). ·         Supply-side approach : supply bottlenecks due to the zero Covid policy in China and central banks’ trade off higher inflation for a speedier economic recovery (the ECB especially). ·         Green transition : this is basically a tax on consumers. What has changed ? The wage-price spiral has started. In countries where the labor market is tight, workers are asking for higher salaries. In the United States, the manufacturer John Deere increased salaries significantly : +10% this year and +5% in 2023 and in 2025. It also agreed to a 3% bonus on even years to all employees, for instance. But this is happening in countries where the unemployment rate is high too. In France, the unemployment rate is falling. But it remains comparatively elevated at 7.6% in the third quarter. Earlier this week, the French Minister of Economy, Bruno Le Maire, called for higher salaries in the hospitality industry. A survey by the public investment bank BPI and the pro-business institute Rexecode show that 26% of small and medium companies are forced to propose higher salaries to find employees. Those which are reluctant choose to reduce business activity. The pandemic has fueled a great awakening of workers, in our view. They are demanding more : better job conditions, higher wages, more flexibility and purpose from work. This is more noticeable in countries facing labor shortage. But it is also visible in all the other developed economies to a variable extent.   U.S. steady rent increase is a game-changer. Until now, supply bottlenecks were the main driver behind the jump in prices. Now, housing costs (which represent about a third of living cost) and prices in the service sector are accelerating too. The rental market is tight, with low vacancy rates and a limited stock of available rentals. Expect rents to move upward in the coming months. According to official figures, owner’s equivalent rent, a measure of what homeowners believe their properties would rent for, rose 3.1% YoY in October. This certainly underestimates the real evolution of rents. Based on data reported by real estate agents at national level, the increase is between 7% and 15% YoY. All in all, this reinforces the view that inflationary pressures are proving more persistent than expected. The moment of truth : Expect investors not to question much the official narrative that inflation is transitory, for now. But if inflation does not decrease from 2022 onwards, investors will have to adjust their portfolio to an environment of more persistent inflation than initially anticipated. This may lead to market turmoil. In the interim, enjoy the Santa Claus rally which has started very early this year. The new inflation regime in the United States