Key Takeaways
This week we’re going to discuss the extraordinary divergence in energy prices between the US and Europe. We’ll suggest that the prospect of sky-high prices for natural gas this winter look set to mean recession in Europe and the UK. By contrast, the strength of the US economy means that the US Federal Reserve will have to keep on raising interest rates until they engineer a recession there.
The price of gasoline is falling in the US
When the price of gasoline in the US rose above $5 a gallon in June, many ordinary Americans thought a US recession would swiftly follow. High gasoline prices = recession is part of the received wisdom in the US. As the yield curve inverted and initial unemployment claims started rising many professional forecaster agreed. Things look very different now. Yes, the yield curve is still inverted but gasoline has fallen to $4 a gallon, unemployment claims have stabilised at a low level and the strength of US consumer spending has surprised the pessimists.
A string of good news on US inflation but rates still set to go up
There has also been a string of good news on inflation but any hope that the Federal Reserve will be able stop raising rates anytime soon has been dispelled by a string of hawkish comments from members of the rate setting committee. As we discussed last week, strong and persistent inflation in US wages and rents means that the Fed’s 2.0% inflation target is out of reach unless and until we get a recession.
Europe can only dream of US energy prices
Motorists in Europe would be thrilled to fill up at US prices – they translate to 90 UK pence or just over 1 euro a litre. But we have reason to be far more jealous over the prices of natural gas this winter…currently trading more than 8 times higher in Europe and the UK than in the US.
This has yet to hit European consumer of course – it’s summer and prices are still relatively low. But the scale of the impending disaster is most obvious in the UK. The typical household energy bill started the year at £1,277 in annual terms. It is set to rise to around £3,600 from October (we’ll learn the exact number on Friday) and perhaps to around £4,200 next January. UK household annual energy bills would, therefore, increase by an unprecedented £3,000 in less than 12 months. There is already some relief on the way from the government but whoever becomes PM next month will be forced to extend this dramatically.
The calm before the storm in the UK
We are in for a few weeks of relief here in the UK. The changes to national insurance thresholds and cost-of-living grants means that real disposable incomes are receiving a healthy boost this month. And many consumers still have room to spend their covid piggy bank – cash accumulated and debt reduced during the pandemic. But it really is the lull before the storm.
The mighty dollar could get even mightier
It is hard to escape the conclusion that economic prospects are much better in the US than in Europe. The mighty dollar could get even mightier and although interest rates are headed higher in Europe and the UK, the US must surely lead the way. And risk assets? Rising rates and recession do not add up to a bull market in equities in my humble opinion.
So enjoy the rain if you get it – something I never expected to say in this country – and I’ll be back next week. (A day later given the bank holiday)
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