Russia Gas Standoff Takes Main Stage at Currency Market

Russia's pipeline reopening

Russia’s reopening a critical gas pipeline may be a bigger deal for the Euro than the ECB’s planned first interest-rate increase in 10 years, both coming July 21. While the markets doubt the genuineness of Russia’s plan to restore gas flows to Europe after the completion of maintenance on the Nord Stream 1 pipeline, the ECB’s plans to start lifting rates appear a done deal, and there is no more noise concerning it. Russia’s gas supply has been running at only 40% of normal levels after Moscow cut flows earlier in 2022. Another disruption might cause rationing ahead of winter when energy demand rises, which would put ECB’s continued rate hikes at risk.

European officials have openly discussed the risk of a complete shutoff from Russia. This feared situation will cause a downward turn for energy prices, ultimately leading to a recession. That will compound Euro’s worries as it is already on the edge of parity with the USD.

Kaspar Hense, a senior portfolio manager at BlueBay Asset Management, said, “The 21st is going to be a key day, more for the outlook for gas supplies than the ECB”.

The ECB’s strategy to lift the currency by raising borrowing costs from sub-zero levels has been unsuccessful. This is because other major central banks have tightened policies to tackle inflation. Money markets bet that ECB will lift rates by at least 125 basis points this year; however, Federal Reserve has already done more, dragging the Euro down to a 20-year low versus the dollar. In addition, Euro is tracking moves in natural gas prices, with many market participants naming Dutch gas futures Euro’s driving force in recent weeks. 

Kit Juckes, Chief FX strategist at Societe Generale SA, wrote in a note, “The worst-case (total stop of gas flows) brings recession and probably another 10% fall by the euro from here”. But, he continued, “the best case, a continuation of the status quo, leaves markets nervous and the euro only able to manage modest short-covering relief”.

Aaron Hurd, portfolio manager at State Street Global Advisors, said, “If gas is cut off, I’m thinking euro-dollar could be 90 (US cents) — then we’re probably 60% priced for severe gas shock, which I think is playing out”. He further said that “people are legitimately worried about whether or not production is turned back on after maintenance.”

The market is pessimistic as they plan their doom, hoping for the worst. What if Russia cuts Europe off?

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