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Eurovision – dollar and commodity prices push Europe into recession

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Look away from what’s going on in the UK if you can for one moment – it’s about time to turn the spotlight onto Europe…

We start with Germany, where Europe’s largest economy has seen its trade surplus completely eroded, turning negative and falling into the first deficit since 1991. Obviously, the biggest factor in this is the reduction of Russian gas imports.

Germany has been heavily reliant on Russia to fuel its powerful economy, but as the spectre of gas rationing through the European winter emerges and a potential government bailout of Uniper [ETR:UN01], the Düsseldorf-based energy company, and Germany’s largest gas importer, becomes likely, Germany’s economy is starting to cool; as if someone turned the hob off that’s keeping it bubbling.

Euro-recession

A recession in Europe looks all but certain this year, and this makes the ECB’s life incredibly challenging. The continent has a deteriorating growth outlook, very high and persistent inflation and worries about peripheral bond yields blowing up.

EU Natural gas (NG) prices is not something the ECB can control, and the commodity has seen prices rally 100% in the past 16-days; this is becoming a brutal juggling act for Europe. Europe is in the eye of a storm right now, especially with China maintaining a strict line with its Covid-zero policy. News that airline SAS [STO:SAS] has filed for bankruptcy won’t help matters either.

Europe may be the sick man and commanding the closest attention, but this is a global problem. In a world of rising interest rates and central banks hell-bent on putting the inflation genie back in the bottle, we’ve seen clear evidence of demand destruction.

Commodities have been the default expression of this theme, and right now there is just no clarity on growth, or what can change the downward trend. Even though the market lives in the future, it feels like this is going to get worse before it gets better.

No one wants EURs, or GBPs, and commodity currencies such as AUD, NZD and NOK are finding few friends. As the saying goes, the trend really is one’s friend, but the question on trader’s lips is when will EUR:USD hit parity?

Dollar dominance

Right now the dollar is reigning supreme, not just from a relative growth perspective, but as an attractive investment destination. Aside from USD, only JPY feels like a compelling long call. What is clear is that dollar strength is feeding back into negative commodity price action, as buying dollar-price commodities becomes more expensive to purchasers as they have to exchange their own currencies for ever-strengthening USD.

As a result, commodities face a war on two fronts – demand destruction and the strength of the dollar. This is causing some intense bear trends in commodities. It wouldn’t be a stretch of the imagination to think the systematic trend-following crowd would already be running hefty, short positions in copper, silver, gold, US gasoline and agricultural commodities like wheat and soybeans.

Gold Spot / USD

Until we see signs of a turn in the USD, then rallies in all these markets will likely be jumped on by the short-sellers. That even includes XAU:USD, which is trading at YTD lows and sold consistently into the 8-day Exponential Moving Average (EMA). Until these dynamics change then it feels like gold is destined for $1750.

If the USD remains bid, perhaps look at gold exposures in AUD or EUR (XAU:AUD or XAU:EUR) and there remains the scope for a topside range breakout. Even then, I recommend waiting for a move to take place to allow the market reveal itself.

Cooling-off crude

The elephant in the room, aside from EU NG is crude.

Our SpotCrude price briefly traded below $100 and SpotBrent into 103.53, although both have been supported below the figure. Headlines that one US bank is projecting that Brent crude could head to $65/bbl in a recession may have impacted, but it’s the demand side of the supply/demand equation which is being examined.

Notably, concerns of falling demand from Vitol Group, the privately-owned Swiss energy and commodity trading house, one of the world’s largest oil traders on Sunday, may be a barometer as to how trading may move in the coming months. This is good news – the world could use a weaker crude price, although from a risk perspective it is better if the depreciation is driven by additional supply, not falling demand. The issue with supply is that OPEC is struggling to meet current quotas as it is, so bringing on additional supply seems a tall order.

WTI Cash Contract 1 Day

Having broken the April trend support, the rising probability is SpotCrude will test the March/April lows of $93.47/93.98 – selling rallies into 104.00. Commodities are the default expression of recession risk – crude and gold get the flow from clients but for those who like momentum and trend, this is the space to pay attention to.

This article is brought to you in association with Pepperstone. All opinions expressed in this article are from the author and do not necessarily represent the opinions of The Armchair Trader.

This article is not investment advice. Investors should do their own research or consult a professional advisor.

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This article does not constitute investment advice. Do your own research or consult a professional advisor.

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