Stagflation Threatens the Global Economy Accompanied by a Serious Sovereign Debt Crisis

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The rise in gas prices over the past two weeks and uncertainty regarding gas supplies in the short and medium term have once again brought macroeconomic issues to the forefront, particularly the fear of recession, especially in Europe. The President of the World Bank warns that the global economy is threatened by medium to long-term stagflation. Many countries are already facing significant challenges in surviving this crisis, despite assistance from the IMF. As a result, this crisis will be accompanied by a serious sovereign debt crisis.

After last week’s meeting, the messages sent from FED-a are very clear. They will do whatever it takes to calm inflation and bring it down to the targeted two percent. This means they will continue with more aggressive interest rate hikes, and the market is now speculating that they will increase rates by an additional 0.75 points next month.

The FED’s goal is clear – the priority is fighting inflation, not recession. In other words, they are willing to accept recession and rising unemployment as the price of fighting inflation. Naturally, the capital market reacted negatively to such messages, while the dollar gained momentum. The dollar has strengthened by 13.5 percent against a basket of six major currencies since the beginning of the year.

Is stagflation the new reality? What will the European Central Bank do? How will the euro react? Currently, the euro is below parity against the dollar, at its lowest level in the last 20 years. Some analysts estimate that in the short term, the euro could weaken further, and the EUR/USD ratio could fall to 0.95, primarily due to distrust in the strength of the economies of key eurozone countries.

Preparations for Winter

Analysts at UBS, Switzerland’s largest bank, estimate that the economies of Germany and Italy, which are particularly exposed to energy shocks that could occur if the flow of Russian gas is completely interrupted, could pull the eurozone into recession as early as this year. As with the war, the fall of the euro leads to the merging of several interests: the US is seeking new buyers for its debt after BRICS countries have reduced their demand for dollars; the devaluation of eurozone debt, the introduction of a digital euro that, in addition to enabling complete traceability of all transactions, would allow for significant commissions for the issuer. Like the war, this is not a short-term plan.

Given that we are in August and this is usually a period when the pressure on energy demand is lower, it is logical to ask whether the real energy crisis is just beginning in the EU? Compared to the beginning of the month, the price of gas is currently 40 percent higher, with last week at one point briefly reaching record levels (340 €/MWh) before falling by 18 percent (after Germany announced that their gas reserves would reach 85 percent by the end of September).

Will all of Europe manage to fill its reserves to targeted levels in the next two months, before demand rises further due to the start of the heating season? Maintenance work on the Nord Stream 1 pipeline begins this week, so we have no choice but to wait and see whether gas will be supplied through the pipeline again after the work is completed (even at a reduced volume of only 20 percent) or not.

Norway, which has taken over from Russia as the largest gas supplier to Europe, will reduce supplies due to planned and unplanned maintenance work on gas fields in September. Hydropower and nuclear potential are still not at their maximum capacities due to drought and low river levels. This only shows how dependent we have become on energy sources and how exposed we are, and it could all get worse as we approach winter.

And the price of oil has also risen, currently stabilizing at around $100/bbl. The price here is influenced by limited supply on one side and fears of falling demand due to recession and economic slowdown on the other. OPEC+ members have announced that they may reduce production, especially if Iran returns to the market. I would interpret this as them preferring to see oil prices in triple digits rather than double digits.

Lower Yields in the EU

In the agri world, the main market drivers last week were the exchange rate, the ProFarmerTour in the US, and the drought in Europe which is estimated to be the worst in the last 500 years. Bears in the market are focusing on weak demand due to high energy costs, fears of recession, pressure from Black Sea volumes on prices, and logistical difficulties. On the other hand, bulls are focusing on rising input costs, the drought problem in Europe and Asia, and the ever-present risk of new escalation of conflict in Ukraine.

In the EU, according to MARS estimates, yields will be significantly lower. The drought has damaged crops in Italy, France, Spain, Germany, and the Balkans.

The estimated corn yield is 6.63 t/ha, sunflower 2.06 t/ha, and soybeans 2.46 t/ha (all three down by 5 to 10 percent compared to the July estimate). The corn harvest estimate has been reduced to 59.3 million tons (from 65.8 million tons), but some believe a more realistic estimate is 55 million tons. Additionally, 20 million tons of corn imports are expected in the EU. The question is just from where?

The wheat harvest is estimated at 126 million tons, while wheat exports from the EU are estimated at 36 million tons. In Ukraine, a grain harvest of 54 million tons is expected, 32 million tons less than last year. The wheat harvest is estimated at 18.2 million tons (vs 32.2 million tons last year), while the corn harvest is estimated at 28.5 million tons (vs 42.1 million tons last year).

Since the export corridor was established, about one million tons of goods have been exported. This is still insufficient to relieve pressure on storage capacities ahead of the upcoming autumn harvest. According to data collected through the ProFarmerTour in the US, the corn harvest is estimated at 349.5 million tons (vs 364.7 million tons according to the last USDA report). If this is the case, it will be the smallest harvest since 2012.

The soybean harvest estimate is 123.4 million tons (vs 123.3 million tons according to the last USDA report). Simply put, the data is bullish for corn and neutral/bearish for soybeans. If the US were to lose an average of 10 percent of yields on corn and soybeans, it would mean a production shortfall of 50 million tons!

Price Stability Ahead of Economic Growth

From other news in the agri world, fertilizers should be highlighted. Yara could reduce production in the EU by up to 70 percent. Many other fertilizer producers in Europe are announcing reductions or halts in production due to high gas prices. In France, reduced fertilizer use has led to a decrease in protein in wheat. The same has happened in Germany.

India has approved restrictions on the export of wheat flour to calm inflation in the domestic market.

The rain that has fallen in Europe in recent days is more than welcome as it will encourage producers to start sowing rapeseed. Optimism also prevails in Brazil regarding the upcoming soybean sowing. Current weather conditions for sowing are favorable, and an increase in hectares and higher yields are expected, which could lead to a record harvest of 150 million tons by early 2023.

The price of copper, like other metals, is falling mainly due to fears of falling demand. Many countries are announcing further interest rate hikes in the fight against inflation, which will lead to a slowdown in economic activity. Copper, which is considered one of the indicators of the health of the global economy, could face a decline in demand as many countries choose price stability over economic growth.

The current price is about 15 percent above the lowest levels since the beginning of the year as lower inventories and reduced production have pushed prices up since mid-July. Copper inventories in LME-registered warehouses fell from 121 thousand tons to 72 thousand tons in early July, while inventories in warehouses tracked by the Shanghai exchange fell to the lowest level in the last 13 years, to just 31 thousand tons.

The price of steel has also fallen, to the lowest level in the last four weeks. Strict restrictions on electricity consumption in China have limited industrial activity, and reduced demand has reflected in falling prices.

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