European Union announces new sanctions against Russian oil
Euro rebound halted ahead of inflation stats, oil keeps rising
Biden-Powell-Yellen will meet today to discuss inflation
Russian oil banned, mostly
European leaders reached an agreement to cut around 90% of the oil coming from Russia by the end of the year. The aim is to deal another blow to the heavily sanctioned economy and diminish Putin’s ability to wage war, although this decision will also inflict collateral damage back on Europe by pushing energy prices even higher.
The oil market is already exceptionally tight, with inventories being drawn down to meet demand as summer travel ramps up, and restricting supply any further leaves only one escape valve - higher prices. Consumers are already feeling the heat from surging oil prices and the rally isn’t slowing down despite lockdowns in China and the turmoil in stock markets.
Ultimately something has to give - either more supply comes back online or prices climb high enough to truly destroy demand. Swing producers like US shale or Saudi Arabia are not particularly interested in drilling more, so it seems like higher oil prices are here to stay until there is some positive news from Ukraine. There’s an OPEC+ meeting on Thursday, although not much is expected.
Euro halted in its tracks
The euro disliked the news as even higher oil prices will burn a bigger hole in the Eurozone’s terms of trade, leave deeper scars on consumers, and fan the flames of inflation. Recent data releases show that the French economy contracted in Q1 while Germany’s inflation rate hit another multi-decade high, adding credence to worries that Europe is entering a period of slow growth coupled with high inflation.
Investors are split on how hard the ECB will swing in July. A quarter-percentage point rate increase is fully priced into money markets and there’s an implied chance of around 35% for a bigger, half-point move. The upcoming inflation stats today could help settle this debate.
Overall, the ECB is more likely to opt for smaller and systematic rate hikes to prevent any panic in bond markets, especially now that asset purchases are stopping too. This presents a downside risk for the euro considering the current market pricing.
Dollar stable, Wall Street returns
There wasn’t much else happening in the FX complex, with most currency pairs trading in relatively narrow ranges. The dollar managed to stand back on its feet, capitalizing on rising Treasury yields and the euro’s troubles.
In the stock market, the rollercoaster ride is set to continue. Most European indices are trading in the red today while Wall Street futures point to a neutral open. Investors continue to grapple with heightened uncertainty surrounding the economy as fiscal spending gets rolled back and the Fed closes the liquidity gates.
Valuations have compressed but that doesn’t mean the pain is over as the next shoe to drop may be corporate earnings estimates, which are likely to be revised lower in the face of slowing growth. For the market to find a true bottom, it will likely require a positive fundamental catalyst too - such as the Fed pausing, the war in Ukraine ending, or China abandoning draconian lockdowns.
As for today, the main event will be a meeting between US President Biden, Fed Chairman Powell, and Treasury Secretary Yellen at 17:15 GMT to discuss inflation. The Fed has been adamant it will raise rates to suppress demand, so the emphasis is now on the government to find ways to expand the productive capacity of the economy and quell inflation in time for November's midterm elections.