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Draghi Warns War Could Bring "Drastic" Changes For Europe

Tyler Durden's Photo
by Tyler Durden
Wednesday, May 11, 2022 - 12:14 PM

By Jane Foley, Senior FX strategist, head of FX strategy at Rabobank

Risky assets have been granted a little more of a reprieve this morning on the back of better news regarding Covid in China.  New infections detected within quarantine facilities fell in Shanghai and the city reported that there were no cases of the virus spreading within the community.  This prompted speculation of a potential easing of lockdown conditions in China just a day after the WHO criticised the country’s zero-Covid strategy as unsustainable.  However, the FT has reported that a study from Shanghai’s Fudan University shows that an “unchecked surge of the Omicron variant could result in 112mn symptomatic infections, 2.7mn intensive care admissions and almost 1.6mn fatalities between May and July”.  This underscores the risks of loosening Covid restrictions in China prematurely. 

Further support for stock markets this morning came from President Biden who hinted that some Trump era tariffs on China could be dropped as a way of lowering prices for US consumers.  Stronger Chinese inflation data, however, could counter the improved tone.  The recent lockdowns in China have sparked concerns about supply chain disruption and inflation throughout the global economy.  A recent survey from the American Chamber of Commerce suggested that in Shanghai only 70% of the manufacturing capacity is still functioning with about 2/3rds of firms reporting slowdowns. This morning’s release of Chinese April inflation data brought a stronger than expected print of 8% y/y for factory gate prices, down from 8.3% y/y the previous month but above the market consensus.  China’s April CPI inflation data at 2.1% y/y was also above the median expectation of 1.8% y/y.  Market estimates were made against the backdrop of slowing growth in China.  Stronger inflation data may dampen hopes of further stimulus from the authorities in China which could underpin concerns about global growth.

While the "as expected" final CPI data from Germany will keep the inflation theme rolling in the European morning, the main data event of the day will be the release of US April CPI inflation numbers.  Fed Chair Powell last week took the risk of a 75 bps Fed rate hike off the table for the next couple of meetings, but yesterday his colleague Mester indicated that a move of this size could be possible in H2 if inflation did not moderate.  The market is anticipating that the headline April CPI inflation release will edge lower to 8.1% y/y from 8.5% the previous month.  While data in line with the consensus may be enough to dampen fears that the Fed could consider moving in 75 bps increments in the coming months, at these levels the Fed will be keeping its eye firmly on the inflationary ball.  Two more consecutive 50 bps moves from the Fed are firmly in the market’s sights for the next couple of FOMC meetings. The money market is currently priced for an additional 219 bps of policy tigthening on a 1 year view.

Mester’s hawkish remarks contributed to the erosion of the better tone that had lifted stock indices early in yesterday’s session. The reprieve had followed a plunge in crude oil prices, though this was in part triggered by fears of demand destruction on the back of global growth fears.  The fall in crude prices earlier this week did not translate into lower prices at the pumps for US consumers.  The country is suffering shortfalls of diesel, petrol and jet fuel as the refining system is stretched by the post-pandemic recovery in demand.  This has raised a few red flags for the Biden administration as the summer’s driving season nears. Crude oil has edged higher this morning on the back of hopes that China’s lockdowns may be eased.

Yesterday’s visit by Italian PM Draghi to the White House was aimed at making clear Italy’s allegiance with the West.  On the day of the Russian invasion of Ukraine, Draghi had opposed excluding Russian banks from the SWIFT payments system.  This move triggered a hostile response from former European Council chief Tusk.  Some of Italy’s coalition government parties have also voiced scepticism about the impact of the war on Italy’s economy.  Draghi used his meeting with President Biden to underpin the urgent need for the allies to work on peace negotiations for Ukraine, warning that the war could bring "drastic" changes for Europe. Earlier this week US intelligence officials reported that Russian President Putin could be preparing for a long conflict. 

The economic outlook for the EU remains hostage to issues surrounding energy security.  Yesterday French President Macron and PM Orban of land-locked Hungary continued to discuss possible ways forward for a proposed embargo of Russia energy.  Orban is concerned about the provision of alternative energy supplies for Hungary.  This morning European natural gas prices popped higher after Ukraine reported that flows of Russian gas through a key transit point in the country dried up yesterday.  According to Reuters, Ukraine has blamed the suspension of the supply on the interference of Russian occupying forces.  However, the gas operator has stated that gas supplied would be re-directed through another transit point in Ukraine. 

As the cost of energy and food rises, ministers in the UK are under pressure to do more to ease the pain for the poorest households after the government’s parliamentary agenda in yesterday’s Queen’s speech brought broad based condemnation from opposition parties for lacking fresh support and new policy ideas.  Last week’s the BoE’s latest rate hike failed to lift the pound following gloomy projections from rate setters on both UK growth and inflation.   

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