Surveillance: Euro Weakness with Rochester (Podcast)

Bloomberg Surveillance, folks, it's about bringing in the experts. John and I think we can say John is Jordan Rochester and Nomura is nuanced and different than George Saravellis at Deutsche Bank, is nuanced and different than the giants Stephen Englander over at Standard Charter. And to talk to all those people to read their research helps us call a around this shock that we have. Should we bring in Jordan Rochester? We bring him in right now? You bring

him name Jordan. Why don't you get the extra down side from on your daughter? From where we are down to, say ninety five in August, warning everyone, afternoon, everyone. Well, in terms of why we think euro carries on, the risk is, of course these gas flows, but there's also a global recession story building up. So I think most analysts have now only just realized euro can keep heading lower. There was actually quite a bit of a fight in the sort of cell side community around the one oh

six level when the ECB turn hawk ish. Well now it's quite clear the gas flows dominating, and the reason it goes to is probably three reasons. The first one is the gas flows. We think that there's a high chance that not Turing doesn't resume its operations, and what

we're seeing is a fundamental macro story. Euro dollar is heading lower because European importers of gas are buying whatever they can buy from the US, from Qatar, from as bai Jan. They're just throwing money at the wall to make sure the EU achieves the gas storage aims the roughly around sixty two or sixty six percent full, so they've got a lot more to do and that's forced euros selling all the way until that target is reached.

The second reason, it's China, Okay, continue, sorry, continue continue. The second reason is China. China's COVID business cycle. Before the break, we had a little first word. They're telling us that Shanghai might be going into lockdowns again. That's the biggest trading partner for the euro Area. So demand has just come out of the curve for European exports. And the third one is recession risks, the US raising rates the way they have, the way the world has

moved to the supply chain, and inflation. The ECB is going to raise rates in July, September, October, and so on. But we're talking about rate cuts here at number of next year. I think that's the next trade. And I find it really interesting how there's so much fed cuts price for next year. The curves inverted, but that hasn't happened in euro yet. So that's the next story, and that's gonna weigh on euro as well. So not just

all about gas flows. It's a bigger story. Two stents spread moving from negative ten to a negative eleven basis points. Get your attention, Jordan. You and I were wained on reading Duly fokars landau Garber David fokars landau Over at the big German Bank. Makes real clear at some point we have to step in using euro as a praxie.

Are we anywhere near and a Jordan Rochester zero point nine five where institutions will step in to stanch the dollar strength it's definitely possible, but I think it's unlikely. It's definitely not my base case. I can say that. So when the euro was invented, there was FX intervention, that was the authorities around the world stepped in the Federal Reserve of the Bank of eng and so on to help support the currency. That so that it didn't

spur a Eurozone crisis in its early infancy. So there was a joint effort there, and at the same time, inflation was not as much of a problem as it is today. Right now, every central bank around the world pretty much wants a stronger currency. It helps tame inflation from from import costs. So that's why we're seeing even the likes of the SMB, who have for years fought the curve and try to not have a stronger currency,

they're pretty much asking for one. Well, the Eurozone, they can do that via rate hikes, and I think that's the main way they're going to possibly do that. But as I said earlier, the growth story is much bigger than just the rate hikes. Is what's going on gas in China, but FX intervention is being talked about in Japan as well. Another great example, the authorities there say the move is detached from fundamentals, where most of the charts we look at say actually the move is quite

in line with fundamentals. That's the same with the euro We've had a huge terms of trade shot Tom and German exports have now become very uncompetitive. The cost of electricity and energy in Europe is roughly around six times higher than America. So to make a piece of manufactured equipment you're paying six times more in electricity costs. You're uncompetitive versus an American firm. You need a weaker currency to help you out. Jordan, I want to tease out

the potential cases that you lay out in euros. Recent note is the most likely that you see by mid August or the end of August. I should say that's according cheer latest note. But you said that a ninety print could actually be reasonable to look for over the winter. If we do get a nord Stream one cut down cut off, if a Russia does not restore the gas supplies, at what point does something break? At what point is there a level at which you start to see a

contagion that perhaps is not linear? Well, I think nine five to ninety is non linear. What breaks well. I think credit channels would be much more the area where things breaks. The rise and interest rates we've seen and the drying up a consumer demand, we're gonna see a lot of business models really challenged, and that's where you

have something breaks. The irony of that is if you have credit spreads wide and that leads to a dovish central bank typically and that would mean in lower euro So I still think the exchange rate is the release valve, and I don't think the exchange rate is what's going to cause that stress. It's coming from the supply and the demand side of the equation when it comes to those risks. But look, when we get to five, we're kind of basing that on the north stream one flows

maybe coming back to of their capacity. What ninety cents is that's the scenario where north Stream one does not come back on and the euro area does not get enough gas storage and the German manufacturers get their gas rationed. The Bunder's Bank in Germany have already done the analysis. They expect that's a five percent hit to German GDP if we have gas rationing outside of COVID. That's one

of the biggest economic shocks we've ever seen. So that's a crisis you need that we can currently to help you out, John, and just quickly, we've got to squeeze this in. We're rationing flight to Heathrow. He throw out this morning, basically putting a cast passenger limit on airlines through September eleventh. What did you make of that? How important is that story for you? It's the summer of discontent For a lot of people. This is a personal

story for their own lives. I'm flying next week. I'm flying with British Airways, so maybe this will disrupt my flights. But on on a on a macro scale for the UK, it's going to lead to a summer of discontent. It could lead to higher wages more broadly speaking, and that makes life trickier for the central banks. They're looking at high inflation, looking at rising wages. They should be raising rates in that scenario, but they're also seeing economic crisis

building up in the future in their pipeline. If we have, especially with the gas situation gets worse, so that the center bank is in a really weird place. They need to raise rates to tame inflation, but they'll be looking at negative growth, so that's somewhere of discontent, just keeps central bank in that weird place. What a tough spot, Jordan, Thank you, Jordan Rochester the of the more Cathy Jones

with his chief fixed income strategist at CHERYLS. Schwab. Is a great mystery here, Cathy, that we're gonna be want to be in fixed income with price up, yield lower. Yeah. I think that the time to to move into a little bit more duration has come. And we've been suggesting

that for a while now. You know, when you get tenure yields above three, especially up in that three and a half percent area at a time when the featist tightening and the economy, the global economy is under a lot of stress, I think that that safe haven move and that yield move uh is the way to go. Cathy Anahn was on with a wonderful discussion of the tail risk out there off Curtosis. We rarely talk about tail risk in the bond market. I want to go

there right now. How uncertain is the determination of what price will do in fixed income? Now? How malleable are the tail risks of the bond market? Yeah, it's a great question, Tom. I think the question is we're in the bond market, are we talking about? So we still see a lot of tail risk and credit, particularly lower quality credit, high yield, and even in the private debt markets, there's a building amount of stress there. So I think the tail risk there is pretty high. I think in

treasuries obviously there's some. I don't think it's uh, it's immense anymore, simply because we've had such a massive upward parallel shift in the yield curve and we've got the FED tightening. That combination typically will you know, flatten the curd, invert the yield curve, and so that probably diminishes some of the tail risk at the long end. Kathy, we were talking earlier about Marko Klanovic being an uber bowl and moving to being just a bull when it comes

to risk assets. If you look at his note, it's actually really nuanced, and he has a pretty bold call on credit saying that that is not pricing in as much risk right now as stocks. Would you agree with that? Well, I don't do stocks, so I can't compare the two, but I will say I think credit still has some ways to go in terms of pricing in recessionary conditions. For a further deterioration in UM credit quality and credit performance,

both domestically globally. So when we look at the high yield spread, you know it's moved up quite a bit, but we think it can move up another hundred and fifty basis points or so if we get into a pretty sharp downturn here, which looks like that's where we're headed towards the second half of the year, sounds like it could be controlled or could be uncontrolled based on

the pace of it. And I think about what Michael Schowell said yesterday on the show, where he was saying that we could start to see real market dysfunction that could actually get the fence attention. Do you see corporate credit as being vulnerable to that type of fissure that

he's talking about. I think the problem in corporate credit is the liquidity issue UM So, yes, at the at the very low credit quality, we could run into some problems there, and I think access to the market would be really difficult and probably is getting more difficult for say triple C rated low rate of UH corporate issuers. But I think in the investment grade space, what we worry about is just liquidity because the dealers are not holding as much the banks. The dealers are not holding

as much. A lot of it has moved into the private market. If there is a dislocation, it's simply the inability for the market to get the liquidity it needs to get that the price and yield right, and we could see some problems. They're not anticipating it, but it certainly could happen if things deteriorate quickly. Kathy, thank you,

always wonderful to catch out with you. One of my favorites, Kathy Jones, that have challenged swamp and joining us now I could he stranagis at Wells Fargo Securities and this volatility, this mess, whatever you want to call it, do we need to get comfortable, get used to it. Is it going to stick with us for a while. Well, I don't know if you can say comfortable, but we do think it's going to stick around. John, I think a lot of the volatility we're going to continue to see

somewhat ever outlier moves on the day. Aggressive rips up, aggressive drops down, and that's gonna probably persist until we really see a science from the said that they're easing off the gas pedal in terms of their hiking schedule and know your notice brilliant. It goes all massa tellub where you say, forget about the probability distribution, forget about the center tendency of crude hostess and such. Look at

the tails. Look at the tails. What does the left tail, the sweat of the left tail, the fear of the left tail. What's it look like right now? We would put it in context of really what sort of investment style we're thinking about. At the left tail, we're thinking about what have been the worst performers. What does that low momentum basket really signaling? And we have this kind of stress scenario and what looks to be for us base case of recession. You've heard it time and again,

base case base case. What's driving that you're seeing these really poor performers be the broken stories here? And when you have that situation, we think that can persist, so to us where advising clients avoid that low momentum basket, don't go bottom fishing here, and also avoid the high risk basket and lean more towards that low volatility if you're worried about that recession that's at least in the investment styles but you also have to think of this

in context of inslation. What are the potential drive is that might bring inflation off the boil? What are the extreme cases and we don't see those extreme cases really relieving us of a CPI print below eight and a half for the rest of this year. Inflation has been a story that a lot of people have been talking about and obsessing over for most of the year. But now it's the strong dollar and what that does to the SMP two companies that derive about thirty percent of

their revenues from overseas. How much of that has been baked in and how much do you expect that to be really a headwind during the setting earning season for what equity valuations do well, Lisa, I don't think it's fully really baked in now, you know. I wish I could pinpoint and put a number on it for you,

But you bring up a great point. You know, the dollar is strengthening, and that strengthening is coming from the different pace in which we are tightening monetary policy versus countries in comparison, and what that does to earnings and already earnings and margins that are under pressure, it's going to add another weight to the US corporate earning season, and I think that itself has cause some of that

volatility we're talking about. People are worried can we continue to grow earnings at the pace at which people are hoping for and what looks to be a slowing GDP growth a weakening consumer and that growth is going to be really what drives confidence and equities and what really what dictates the direction for the rest of the year, and the cause of a lot of this has been the energy industry and the price accrued, the price of energy, the price of gas. Do they become the victim of

the solution? Can I belong those names into year end? If I'm expecting that kind of GDP deceleration, Well, I think there are ways to be exposed to the energy markets and play that carefully. But for us, we think on a broad scale, looking at oil and commodities, they may be peaking here. Now that doesn't mean that they're going to be rolling over quickly or rolling over strong

enough that CPI comes down aggressively. But we do think that in many instances and cases that we may be seeing the top here and other aspect of that and where we might see part of that being a hinted at is you look at how much the market believes that the impact of energy has on cp I might be reduced. As you look at break evens, you see break even rolling off from what had been above three hundred basis points now down to maybe three seventy three

to thirty excuse me, two basis points now. That's telling you that it's starting to weaken as an impact. And that's where we're getting our signal that maybe oil and commodities really are reaching their peak. An awesome stuff. As always at once Founder Securities, thank you right now. Ellen Wald was a senior fellow in Atlantic Council on Oil on strong dollar, which harkens back to another time in place and petro dollars. Ellen, what does a strong dollar

mean for your oil world? Yeah, it's you know, things are things are quite uh incredible in oil right now. And as we're seeing, um, you know, prices are kind of going on on a rather almost like a roller coaster up and down. Um. Fears of recession uh tend to send the prices down because there's a sense that this will reduce demand. But then the next thing you hear is, you know, demand is so strong, uh still,

and so then you you see prices going up. I think that the news of Heathrow reducing capacity could actually are putting capacity limits. The idea that that could potentially reverberate across other airports could put a damper on on travel and jet fuel demand as well. Is there a linkage of petro dollars to declining oil demand? You know, that's a really good question, and I think at this point, you know, we're not really seeing a drop in demand.

You know, we've looked at gasoline stats. You know, some weeks we're seeing a drop, in other weeks we're seeing an increase. So um, I think that we have seen some declines in terms of demand instruction, but not a whole lot. Uh. There's a lot of pent up demand.

It doesn't seem like the dollars really affecting demand all that much at this point, Ellen, which raises a question of when we're going to see a pop in oil prices, given that even fought b role as we were just hearing from the i A came out and said, this is a global energy crisis in a sense that we have never seen before in terms of complexity and speed. When do we see that translate into the higher prices that so many people are expecting and the prinkly you're

seeing in the physical market. You know, it's so interesting because we're seeing a lot of calls for either you know, oil will either go to two hundred and thirty dollars of barrel or it could go down to sixty dollars a barrel, and that's a that's a huge, huge margin here, and I do think that it reflects a lot of the uncertainty. Uh And and facty Bureau is correct to call attention to a lot of the issues that we're seeing today. I mean, look at what happened in Sri Lanka.

That could be next for many, many more countries and not just developing nations. But we could absolutely see fuel crisis around the globe. And uh you know, part of that is due to historically low investment in fossil fuels, and you know that that trend is not really reversing itself at any point, and this is precipitating a huge energy crisis. Ellen, does any part of the capping of energy prices from rush or at least the energy prices

that they receive. Does it make sense to you in terms of its feasibility and a rollout and getting everyone on board. Or is this basically highlighting the lack of tools right now available to really curtail the crisis that people are talking about. Yeah, I I just don't see how imposing a cap on Russian oil prices is at all feasible because, uh, you know, say you even get Indian China, which are the biggest buyers of Russian food right now, you say to them, okay, only pay this

amount for Russian food. And the idea is that Indian China will want to pay less. Of course they want to pay less, but will the Russians want to sell them for less? Russia's in. Russia's holding the cards right now because if Indian China want their oil, they can say, sorry, you know, we're not going to sell it for you know, forty under under the benchmark. We're offering you a twenty

dollar discount. And our Indian China really going to say no. Are they going to risk, especially India, having a fuel crisis in their country? Uh? Just because the West is saying we want you to cap the price of Russian oil so that you know it'll hurt putin In his war against Ukraine. They're they're probably looking at saying Ukraine, what Ellen you just mentioned Sri Lanka. And I'm very

curious about the contagion effect here. When a given poorer country, beleaguered by high oil prices provide subsidies domestically, where do they get that money? Do they issue debt or is it a bail out from the I m F. I'm guessing that they first issue debt and then they're hoping for a bail out from the I m F. And if that's not, you know, coming uh, then then they're gonna see some serious problems. And we're seeing not just uh, you know, developing countries do this, but we're seeing it

in more developed countries as well. Offering these kind of subsidies, are trying to to subsidize their cap energy prices, and in some cases they're saying to the utilities, you can't charge more than X. Well, if the utilities have to pay more than X for their fuel, then that's just gonna put the utilities in a bankruptcy situation and likely cause them to be nationalized. And then the government's going to take that debt and uh, so on and so forth.

So they're not really solving the problem. They're just kind of kicking it to UH, to other people or to other entities. And well and the Amanti cant so, and thank you. This is the Bloomberg Surveillance Podcast. Thanks for listening. Join us live weekdays from seven to ten am Eastern on Bloomberg Radio and on Bloomberg Television each day from six to nine am for insight from the best in economics, finance, investment,

and international relations. And subscribe to the Surveillance podcast on Apple podcast, SoundCloud, Bloomberg dot com, and of course on the terminal. I'm Tom keene In. This is Bloomberg