PIMCO: Market Commentary – “Wind Speed”

By Geraldine Sundstrom, Asset Allocation Portfolio Manager

Over the last couple of quarters, we have moved from counting vaccinations, to counting cargo ships waiting to dock at ports, to now looking at temperatures, weather forecasts and wind speed. The hopes for a swift reopening boom followed by a period of quick normalization in H2 2021 have all but died.

The impact of the Delta wave on supply chains, in particular from South East Asia, is finally coming to an end with almost all Malaysian and Vietnamese factories coming back online. Further, the China Caixin Services PMI bounced healthily in September, printing 53.4 vs. 46.7 in August, well above expectations. There were, therefore, good reasons to hope that certain shortages might finally moderate in the months to come. But these hopes are being seriously tested by the current energy crisis that is gripping Europe and China, in particular.

The impacts of the energy crisis will be broad-based. Some European households will see a big increase in utility bills, a marked hit to disposable income and sentiment could falter.  After resisting for a while, it looks like China will also increase electricity prices by resetting the 10% increase cap to 20%, even for households. Meanwhile, businesses are usually far more exposed to wholesale energy prices, unless they have fixed contract prices. In China, there will be price increases but partial power cuts will also be a feature to the end of 2021, with many industries seeing power curtailed by 10%-30%. In Europe, wholesale energy prices are leading to anecdotal closing of factories, while fertilizer and aluminium producers and greenhouses in the Netherlands are already going dark, with the domino effects across other industries likely to follow. Overall, we could see renewed shortages in the months to come but likely of a different nature than we have experienced so far.

Of course, there is a genuine scramble to secure more energy in Europe and China but there is no magic bullet. Nord Stream 2 could be started, but Gazprom is already producing record amounts of gas and has to contend with Russia’s own low inventories, plus it is not clear if the German infrastructure has capacity to handle more supply. China has ordered coal mines to increase production, but flooding has already affected its top coal-producing region. Ultimately after the scramble, governments will realise an urgency to regain energy independence. This week, the UK launched a plan to have 100% renewable energy by 2035, while the Eurogroup concluded that green energy is not the problem but part of the solution and reiterated to need to reduce reliance on imported energy.

For sure, the coming earnings’ season that begins next week in the U.S. will be heavily scrutinised for pricing power, margins and clues on the shortage situation, as well as wage pressures. Already a number of large multinationals have issued warnings about production cuts and downgraded their Q3 outlook due to supply chain and labour shortages. On the macroeconomic side, inflation prints will surely see renewed interest and keep central bankers sweating.

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