How is geopolitics contributing to the rise in commodities? Report

2 October 20213 years ago babelfish

“Impacts of the stagflation phase, with possible“ full eyes and half-empty hands ”effect”. The analysis by Antonio Cesarano, Intermonte's chief global strategist.

Let's try to make a rundown on the current economic phase, focusing on the main theme that is the energy crisis that potentially becomes threatening in view of the winter, concluding with the possible operational implications.

What economic phase are we going through?
• Overall stagflation, a phase we haven't experienced since the 1970s, once again caused by a commodity supply side shock. In this case, more than oil, the protagonists are the energy commodities useful for the production of electricity, gas (in Europe) and coal (in China), in the lead
• This particular economic phase, however, is experienced with a focus on the two separate sub-phases like two frames of a cinematographic film:
or now a lot of attention on “flation” given the increasing levels of raw materials and consequently of inflation.
o Subsequently (presumably from November onwards) the focus could shift to the impact on growth (the “stag”) deriving from bottlenecks, especially in the Asian supply chain.

Signs of a slowdown are emerging, lastly the Chinese SME in September below 50. What is this due to?
• You are moving from one slowdown factor to another. First the closure of some important ports due to infections, albeit very limited. Then now the issue of electricity rationing which is leading several provinces in China to downsize production. The post-pandemic demand peak is leading to the widening of bottlenecks more and more evidently, as evidenced by the Chinese manufacturing PMI data for September below 50.
• A fourth quarter is therefore expected to be potentially marked by a cut in the growth estimates for 2022 and for companies a possible cut in the guidance on turnover and margins, due to the impossibility of finding adequate supplies of components / raw materials in any case at costs increasing

What is the reason for the sharp rise in commodities?
• First of all, I specify that the rise is widespread but the epicenter is located in the raw materials connected to the production of electricity, in particular gas and coal. In Europe, the focus is above all on gas, being a fossil fuel with a lower environmental impact in a context of renewables that still cannot replace fossil fuels and moreover have highlighted the weak point of their intermittency, in the absence of a system on large scale of energy conservation.
o In perspective, the hydrogen "cell" will be important on this point, which will probably rise even more to the top priorities of investments planned for the energy transition, probably as early as 2022. Renewables without batteries, it is like power without control
• The rise in raw materials is however partly explained by geopolitical considerations.

How is geopolitics contributing to the rise in commodities?
• There will be major political changes in Europe between 2021 and 2022. After the German elections (and the consequent end of the Merkel era), the French presidential elections will follow in April 2022. During this phase, the US is downsizing the strategic importance of the Mediterranean to devote itself primarily to containing China, even from one point of view. of military point of view.
• In this context, Russia and China probably try to orient the new geopolitical attitude of the area towards them and, to facilitate everything, they make their importance weigh, slowing down the supply chain, Russia with gas, China with components and, lastly, phosphates important for fertilizers (export stop for 2022) and of which China is the world's leading exporter. Also for these reasons, the levels of gas stocks in Europe are at very low levels for the same period, exposing them to the risk of an energy crisis, especially if the winter is not mild.

As for the operational implications, what kind of scenario for rates and exchange rates?
• On the interest rate front, the stagflation phase could progressively “split” the interest rate curve. Now the focus is all on inflation and related tapering on the way and as a result we could see a temporary phase of long-term rate hike until the tapering really starts, presumably on November 3rd. At this stage, the US ten-year could go as far as equaling the high of last March in the 1.75% area
o Then, when the focus (from November onwards) is on the slowdown in growth, we could see a dichotomous trend:
 the part of the rates up to 5/7 years up to follow the maneuvers of the central banks
 the part from 10/15 years onwards in the opposite direction to follow the slowdown.
 The curve therefore flattens out which, in bond jargon, is equivalent to a signal of an upcoming slowdown, partly already arrived because the curve has been flattening since last April.
• On the foreign exchange front, the eurusd reached the important threshold in the 1.16 area, mainly driven by the widening US / Germany rate differential but also by flight to quality due to the discussions on the debt ceiling in the USA and I also add on the spur of the rush to hoard raw materials, to avoid shortages in winter. Commodities are paid for in dollars and this strengthens the demand for the greenback.
• The movement in October could record an eventual overshooting, possibly up to 1.14 area but then at the end of the year the focus on the slowdown could lead to the hypothesis of more gradualness also by central banks and, therefore, a temporary return to 1.18 area / 1.20.

And on the equity front?
• The (temporary) phase of rate hikes could involve deeper and more frequent dips, with an eye on around the 20th of the month, a period in which the most important drops have occurred so far from May onwards. This time, October 18 is the time when the US Treasury could effectively run out of resources in the absence of a suspension / increase in the debt ceiling.
• Overall, however, the dip could be positively exceeded at the end of the year thanks to the expected decline in long-term rates induced by the aforementioned slowdown in growth with a view to 2022.
• The first warning bell on the stag theme could come not only from the macro prospective data but also, and perhaps even before, from the US quarterly reports in the second half of October. In this case, we could see frequent cuts in guidance on the turnover / margins front. Companies bear increasing costs and, above all, fail to have adequate supplies with the pace of demand.

In other words, full eyes and hands… half-empty or, as Eduardo De Filippo said, “adda passà a nuttata”. In this case, the "nuttata" is winter.

This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/stagflazione-effetti/ on Sat, 02 Oct 2021 06:29:42 +0000.