Winter is approaching, Europe faces challenges

The Bank of England is expected to cut rates in the second half of 2023, but if it eases too soon, it may need to eventually raise rates again. HSBC economists said in a research note that if the Bank of England cuts rates before inflationary pressures dissipate, it could "reignite the fire" and force the central bank to change its approach. Inflation is likely to remain elevated for a longer period of time, and Brexit is also one of the factors that will keep it going, in addition to the policy stance of Truss, the favourite to be the prime minister. Brexit has pushed up input costs for businesses, limiting immigration into the UK and reducing labour supply.

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Much uncertainty remains about when and how quickly the balance of the Fed’s reverse repurchase (RRP) facility will begin to decline. Citi expects RRP usage to increase in 2022 and then decline in 2023 due to increased supply of U.S. Treasury bills, lower QT-driven liquidity, and increased interest in duration in money funds driven by recession fears. If RRP usage remains sticky and does not decline, the Fed is expected to drive money away by lowering counterparty limits or lowering RRP yields to the bottom of the target range. While lowering the RRP rate may be the easiest thing to do, it may not have much impact; Citi analysis assumes that once reserves fall below $2.5 trillion, the RRP's counterparty limit will begin to decrease, and will be reduced by $30 billion every two months , from the current $160 billion to $30 billion.

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Affected by soaring energy prices, although it is still summer in Europe, Austrians have recently begun to consider burning wood for heating in winter. It is reported that online searches for "firewood" in Austria have surged, and many hardware stores have also pointed out that firewood has been in short supply recently and will not be available until autumn. Shortages are also reported in countries such as Hungary, making it difficult for Austrian shops to import firewood. Also, even if a site has enough forest area, it still takes time for the wood to dry out until it is suitable for burning. The current shortage has pushed up the price of firewood, which is even higher than the price of food and natural gas. The Austrian Minister of Agriculture described that firewood has become the next round of supplies to be snapped up, just like toilet paper during the epidemic.

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TD Securities said a recovery in global economic momentum would hit the U.S. dollar hard. "A key factor in the aggressive bearishness of the dollar is the uptick in global growth momentum," they noted after analysing surprises and trends in global data. "It turns out that surprises and data that are both 'positive' will make the dollar the worst performer." Rising price pressures and tighter financial conditions are strengthening the dollar, making the overall environment supportive of the greenback. “Even so, global data surprise indicators have continued to improve over the past few weeks and could soon turn positive. Combined with inflation peaking and the Fed’s terminal rate, this could change FX market dynamics and drivers again in the fourth quarter. In short , don't get too complacent.

The Nordic Summer Informal Meeting of Heads of State was held in Oslo, Norway, with topics including Nordic defence cooperation and the development of environmental issues. Leaders of participating countries discussed issues such as security policy, ocean protection and renewable energy promotion. Prime Minister Steller of Norway, the host country of the meeting, called the meeting historic in his opening remarks as Finland and Sweden applied for NATO membership. Danish Prime Minister Fraser Ricksen said in his speech that Europe must get rid of its dependence on Russian energy as soon as possible, and the solution lies in renewable energy. Finnish Prime Minister Marin said that the Russian-Ukrainian conflict has raised energy prices in Europe and a solution must be found.

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The risk of a recession in the euro zone has reached its highest level since November 2020 as energy shortages threaten to push already record inflation higher. The probability of economic output shrinking for two consecutive quarters rose to 60% from 45% in the previous survey, up from 20% before the Russian-Ukrainian conflict. The German economy could come to a standstill as early as this quarter. Rising living costs are hurting euro zone businesses and households, and Russia's energy threat will make the problem worse in the final months of the year. In addition, severe drought caused water levels in European rivers to drop this summer, exacerbating supply bottlenecks. Euro zone inflation expectations are now averaging close to 8 percent, about four times the ECB's target, and are expected to be 4 percent next year.

Now is the time to short EUR/USD, targeting parity, Mark McCormick, head of FX strategy at TD Bank, wrote in a note. Despite the improving market backdrop, risk assets are not "out of the woods". U.S. inflation peaking and rhetoric like “end the quest for the Fed’s terminal rate” are important factors in forecasting a peak in the dollar, but now is not the time to be bearish on the dollar. It is recommended to sell the euro at 1.0345, target parity, and stop loss at 1.0550.