March 2020 was the the most-volatile month in markets in a lifetime.
In the first half of the month, it became clear that a pandemic would shut down global economies and kill millions of people. That caused a panic.
In the second half of the month, global governments unveiled plan after plan to take on essentially all of the losses from covid shutdowns and disruptions while central banks took dramatic actions to finance it.
That turn was the best buying opportunity in risk assets in a generation.
Are we seeing something similar in European energy?
Like covid, leaders have been slow to realize the scope of the crisis and Russia has compounded that by turning off the taps. But now we're seeing governments take powerful steps. Within a week, reports say the UK will unveil a £130 billion (and open ended above that) plan to cap consumer energy prices and pay the difference for 18 months. If that happens, it basically eliminates the risk to households. There are also hints and reports that businesses will be subsidized as well.
Today, we heard an abrupt turn from Germany economy minister Robert Habeck, who previously said some companies would have to close this winter.
“We will open a wide rescue umbrella,” he said today in a speech. “We will open it widely so that small and medium enterprises can come under it.”
Not every country in Europe is lining up with the same plan. Eurozone countries are floating various ideas on price caps, rationing and subsidies. On Friday, finance ministers will meet and hopefully offer some clarity but you can bet that all the ideas will include a hefty chunk of government spending.
Overall, on the government side, you can start to feel like the covid playbook is in place. Like in covid, mass personal and business bankruptcies will be avoided.
I think that's a powerful short-term signal for European assets, particularly for stocks but also for currencies as the risk of a disorderly crisis dims.
What's different compared to the covid response
What's different is the monetary side. Instead of helping, central banks are actively trying to hurt aggregate demand via rate hikes in order to bring down inflation. The ECB hiked rates by 75 basis points today and said it "expects to raise interest rates further" over the next "several" meetings. The BOE has already embarked on a similar path.
Does the central bank stance change the calculus?
The bond market certainly isn't happy. UK 30-year gilt yields rose the most on Tuesday since March 2020. That could be a sign of things to come in Europe, at least once the ECB takes its thumb off the scale. Over time, that will raise borrowing costs for consumers and businesses, which is a problem for spending and investment.
Feeling isolated
What's also different this time is that this is largely a European crisis while covid was global. There was certainly volatility during covid in FX but in the energy crisis, it's EUR and GBP-specfic. That has created one-way flows and one-way moves that weren't there during covid. Growing expected trade deficits for both the UK and eurozone have weighed on the currencies and threaten a vicious cycle of imported inflation.
And all that debt
There's a limit to how much debt a country can tolerate. Covid punched a big hole in government balance sheets but it was easy to hide (and ignore) with central bank support. Now -- at the same time that central banks are lifting the veil on the debt problem -- governments are going to punch another covid-sized hole in the balance sheet.
What all this does is take a short-term crisis and transform it into a long-term problem. The risks are also growing that as debt spirals, it becomes a long-term crisis with no way for governments to spend their way out (just the opposite).
For now though, a potential crisis for business and consumer balance sheets has been moved to the government balance sheet -- just like covid. It was a powerful signal last time and I believe it's the same thing this time, especially for European equities. Beaten down banks look particularly attractive, since they will be shielded from bankruptcies. While the path is less-clear for the euro and pound, I think it will eventually be the case as well, though the market may need more time to see how energy supply holds up and whether we see thoughtful European coordination or beggar-thy-neighbour policies.