Steno's Signals #30 – Recession time and big news!

The ECB still lags European inflation by several months, while a Chinese reopening is not necessarily bullish for oil. Find out why as we reveal our new research service!

Dear loyal readers of Steno’s Signals.

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European inflation has peaked, but the ECB will follow the Fed playbook…

European inflation has peaked. That is safe to say by now, but it doesn’t mean that we have seen the peak hawkishness from the ECB yet. The best leading indicator of Eurozone inflation is Spain as the pass-through of energy price trends is swifter in Spain relative to the Euro area aggregate. Judging from Spanish trends, we ought to expect Euro zone inflation of around 6-6.5% in just two months from now.

Sadly, Christine Lagarde (and the ECB) further lags the inflation curve by 3-4 months, which means that Spain's inflation overall tells you what the ECB will think in about 6 months from now. This is evident from watching correlation patterns between the 1y1y EUR forward and inflation trends. Central banks have never been as lagging as today, which is probably a result of the “average inflation targeting” love affair from 2020/2021.

“We want to see actual progress, not forecasted progress.”

Chart 1. Spain tells you what to expect from the Euro area and the ECB in advance

European core inflation has on the other hand not truly peaked, and everything points to a continued six-month lag pattern between US and European core inflation.

Wage dynamics are slower in Europe meaning that the wage pressures that emerged through 2022 in the US will emerge through the spring of 2023 in Europe. Lagarde and the ECB forecasted 4.2% core inflation for 2023, and if they follow the J-Poww playbook, they intend to bring front-end real rates into positive territory before claiming victory. That still leaves some upside in front-end EUR rates relative to the current pricing.

Chart 2. The European core Inflation lags the US core inflation by 5-7 months

But… forecasting central banks suddenly became a bit trickier after last week. The recession is now here. We don’t really doubt it anymore as a landslide in ISM Services New Orders to levels substantially below 50 is an early hint of a (material) slide in real consumption.

Chart 3. ISM Services New Orders scream recession

The tricky thing is now to assess how markets will react once the recession becomes increasingly evident in the coming months. Will the equity market rally due to hopes of a Fed pivot or will the weakening fundamentals lead to another sell-off in assets?

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Andreas Steno on behalf of the entire Steno Research Team

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