Freezing winter weather may seem like a distant concern for continental Europe, which is currently experiencing sweltering heat. However, recent events have served as a reminder to traders and strategists of the fragile energy security and bond-market risks that persist.
Last week, the price of wholesale gas skyrocketed by almost 30% in a single day due to strike threats in Australia, causing a jolt among investors. In light of rising energy prices, ING, Rabobank, and Saxo Bank are recommending positioning for a hawkish pivot from the European Central Bank (ECB), as officials aim to prevent long-term inflation expectations from rising further.
Benjamin Schroeder, senior rates strategist at ING, noted that “suddenly some inflation alarms are ringing again” as recent swings in natural gas prices highlight the lingering risk of supply disruptions. The market’s attention is now focused on the ECB’s own inflation expectations survey, set to be released on Monday. Additionally, the UK, which lacks natural gas storage, is grappling with the impact of energy prices on various markets. New inflation data from Britain is expected on Wednesday.
While Europe currently has ample cold-weather supplies, it is still paying four times more for energy than the US and roughly double the pre-pandemic prices. The surge in energy prices has also pushed a market gauge of long-term inflation expectations to its highest level since 2010, making it difficult for the ECB to justify ending its tightening cycle.
Schroeder cautioned against jumping into curve-steepening trades, which involve betting that yields on longer-dated bonds will rise faster than shorter notes. He emphasized that markets should not underestimate the ECB’s “resolve and persistence.” Europe’s reliance on liquefied natural gas imports has been amplified by Russia’s invasion of Ukraine. The region’s efforts to reduce its dependence on Russian energy supplies have fueled inflation, and any disruption to global energy markets could further exacerbate price pressures.
Currently, money markets are pricing in a 40% chance of a quarter-point hike from the ECB in September, with an additional 66 basis points of cuts expected next year. Rabobank echoes the view that the ECB will need to demonstrate “more determination” in addressing inflation, given the risk of further energy shocks. Lyn Graham-Taylor, a senior rates strategist at Rabobank, emphasized that energy is a crucial factor for the ECB to consider.
In conclusion, the recent surge in energy prices has highlighted the vulnerability of Europe’s energy security and bond markets. Traders and strategists are closely watching the ECB’s response and its inflation expectations survey. With the region still heavily reliant on imported natural gas and susceptible to disruptions in global energy markets, the ECB may need to take decisive action to address inflationary pressures.