Coming into 3Q’22, the Euro was facing a litany of issues that seemed to prevent any sort of significant rebound: slowing economic growth; the ongoing Russian invasion of Ukraine; questions over energy inventories; and concerns around a potential fragmentation of European bond markets. Now, heading in 4Q’22, it’s clear that all of the angst around the Euro was well-founded; each of the aforementioned issues turned out to be much more dire than almost anyone imagined.
Eurozone Stagflation on the Horizon…
The harsh reality of the situation facing the Euro over the next few months is that the Eurozone is facing a trifecta of an economic nightmare: PMI readings point to a contracting economy; labor markets are starting to slow down; and inflation rates are holding near multi-decade highs. In other words, stagflation.
Russia’s invasion of Ukraine is compounding the problems, as a tit-for-tat sanctions response has seen gas supplies taper off dramatically to Europe. The situation has become so dire that, at times in recent weeks, the benchmark European natural gas grade, Dutch TTF, has traded for more than what’s equivalent to Brent oil at $500/barrel.
Winter is coming and the Eurozone is wholly unprepared. If energy prices stay elevated, it’s entirely possible that several industries – manufacturing in particular – shutter completely before spring arrives. The prospect of a sharp economic downturn is at the forefront, and the European Central Bank may not be able to raise interest rates for long if growth contracts aggressively.
…and a Potentially Revived Debt Crisis
The election of Giorgia Meloni, Italy’s first female prime minister, is a watershed moment for a different reason: it marks the first time that a right-wing government has taken power since World War II. Granted, Italy tends to run through its governments quickly – the Meloni-led coalition will be the 70th government since 1945 – but the antagonistic attitude that Meloni has towards the European Union is surely unwelcomed.
The European Central Bank has already taken steps in recent months to shore up Italian debt amid its interest rate hikes, through a program aimed at preventing fragmentation of European bond markets known as the Transmission Protection Instrument (TPI). If the Meloni-led Italian government proves as antagonistic to the European Union as some people fear, then concerns about Italy’s fiscal standing could erupt over the coming months.
Needless to say, the problems that were kept at bay or at the margins coming into 3Q’22 are now front-and-center at the start of 4Q’22. The Euro is heading into a storm for the remainder of this year and early next year; the present set of circumstances is a daunting fundamental backdrop.
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