The European Central Bank is planning to reopen a key Russian gas pipeline next week, which could be a bigger deal for the euro than the first interest rate hike in a decade.
Both are scheduled to be held on July 21. While the ECB plans to start lifting rates have been well flagged and priced in by markets, there is more doubt whether Russia will restore gas flows to Europe after maintenance on the Nord Stream 1 pipeline is completed.
The risk of a complete shut off would lead to a recession, as government ministers across the continent have been openly talking about it. That would cause big problems for the common currency, already teetering on the edge of parity with the dollar.
Kaspar Hense, senior portfolio manager at BlueBay Asset Management said that the 21st is going to be a key day, more for the outlook for gas supplies than the ECB.
Russia's supply of gas has already been running at 40% of normal levels after Moscow cut flows earlier this year. There's the possibility of rationing ahead of winter, when energy demand rises. It would put further rate hikes by the ECB at risk.
Since other central banks have moved much faster to tighten policy and deal with inflation, the ECB's plans to lift borrowing costs from sub-zero levels have failed to prop up the currency. Money markets are betting it will lift rates by at least 125 basis points this year, yet the Federal Reserve has already done more than that.
Euro Parity Still in Play Ahead of Crucial US Inflation Data
The euro was down to a 20 year low against the dollar, which has dragged it down to a 20 year low. The currency is closely tracking natural gas prices, with a growing number of market participants citing Dutch gas futures as a key driver of the euro in recent weeks.
Kit Juckes, chief currency strategist at Societete Generale SA, wrote in a note that the worst case of gas flows brings a recession and probably another 10% fall by the euro from here. The euro is only able to manage modest short-covering relief because markets are nervous and the status quo is the best case. A total halt of gas supplies is not UBS Group AG's base case, but they see such a scenario leading the euro to drop to 90 US cents. They think it would drive German debt yields down to 0%, with the rate falling this week on the risk.
Markets Plan Doomsday If Russia turns off the gas, Markets Plan Doomsday
If gas is cut off, I am thinking the euro-dollar could be 90 US cents - then we are probably 60% priced for severe gas shock, which I think is playing out," said Aaron Hurd, a portfolio manager at State Street Global Advisors in Boston. People are worried about whether or not production is turned back on after maintenance. The euro bounced back on Tuesday after a test of parity against the dollar. Many market participants argue that the real gains in the currency will be limited until Europe s gas supplies become clearer.
I do not interpret this as a narrative change, bounces can potentially still be sold until the Nord Stream 1 gets turned back on, according to Stephen Innes, managing partner at SPI Asset Management.
There isn't a Gaining Ground for Natural Gas, and the US has plenty of it.