Energy, Expectations, and Estonia

Episode Summary

Executive Summary: The podcast centered on recession risks in the U.S. and Europe, with the panel arguing that both regions are slowing, but Europe faces greater vulnerability because of the energy shock, weaker consumer confidence, and tighter conditions from Russian gas disruptions. Despite rising inflation and soft GDP, labor markets remain resilient, and bond-market signals suggest policy is near the desired “slowdown without collapse” zone.

Main Topics: U.S. GDP revisions and near-term slowdown (Priority: 5/5): Ryan Sweet explained that Q1 GDP was revised slightly lower overall, but the larger story was a sharp downgrade to consumer spending and a big upward revision to inventories, which worsens Q2 tracking and points to a likely negative quarter. Europe’s recession risk and technical recession debate (Priority: 5/5): Gaurav Ganguly described weak Eurozone and UK activity, noting Europe may enter a technical recession faster than the U.S. The discussion clarified that Europe lacks an NBER-style dating committee, so the press often uses “technical recession” for two negative quarters. Inflation as a global supply-side shock (Priority: 5/5): The group argued inflation is largely supply-driven rather than demand-driven because similar inflation patterns appear across countries. The shocks cited were the pandemic and the Russia-Ukraine war. Energy crisis, gas storage, and Europe’s winter vulnerability (Priority: 5/5): A major focus was Europe’s dependence on Russian gas, current storage levels, and the risk that disrupted supplies could force rationing or deepen the downturn. Germany’s emergency gas planning and LNG imports were emphasized. Bond-market and financial-condition indicators (Priority: 4/5): Ryan framed policy using inflation expectations and the yield curve, while Gaurav noted these signals are less dominant in Europe due to ECB intervention and bank-based finance. Peripheral sovereign spreads were highlighted as a better stress gauge in Europe. Labor-market resilience and recession odds (Priority: 4/5): Despite slowing GDP and weak sentiment, job markets remain tight in both the U.S. and Europe. The panel used claims, vacancies, and payroll strength to argue that recession is possible but not inevitable. Commodity prices and recession signaling (Priority: 3/5): Copper and gas prices were used as cyclical indicators. The panel saw falling commodity prices as consistent with slowdown, but not yet with a full-blown recession.

Key Arguments: Q1 U.S. GDP was revised only modestly lower overall, but consumer spending was downgraded sharply while inventories were revised higher, making Q2 GDP look weaker. The U.S. is now tracking slightly negative for Q2 GDP, and the Atlanta Fed’s estimate is also around negative territory, supporting fears of back-to-back negative quarters. Europe may technically enter recession before the U.S. because Q1 growth was weak and Q2 indicators—industrial production, retail sales, confidence, and new orders—are deteriorating. Inflation is probably supply-side driven because inflation rates are elevated across many countries at once; demand shocks alone would likely create bigger cross-country differences. The Russian invasion and gas weaponization are central to Europe’s risk outlook, especially if storage targets are not met before winter. Bond-market inflation expectations are currently near central-bank targets, suggesting markets believe policymakers can slow growth without triggering a severe inflation reacceleration. The shape of the U.S. yield curve and inflation expectations suggest the Fed may be close to the desired policy stance, though the margin is thin. Europe’s bond markets are less informative than U.S. bond markets because of ECB asset purchases and the importance of bank financing. Peripheral sovereign spreads in Europe are the key financial stress indicator, but ECB and EU backstops make a full sovereign crisis unlikely. Strong labor markets, elevated vacancies, and excess savings could cushion the downturn, but that buffer may be temporary if inflation stays high. Recession odds remain elevated but are not certain: Europe is around even odds or slightly above, while the U.S. is viewed as somewhat safer than Europe. If energy prices stabilize or decline and inflation moderates, both regions may avoid a deep recession and instead experience a shallow growth slowdown.

Data Points: U.S. Q1 GDP growth (annualized): -1.6% - Third estimate for Q1 2022 GDP, revised slightly lower from -1.5%. Q1 consumer spending contribution to GDP: 1.2 percentage points - Down from 2.1 percentage points in the prior estimate, reflecting a large downward revision. Q1 inventory build: about $189 billion annualized - Up by roughly $40 billion in revision, making inventories a much larger drag on Q2. Current Q2 U.S. GDP tracking: -0.2% annualized - Moody’s Analytics tracking model after GDP and personal income/spending data. Atlanta Fed Q2 GDP estimate: around -1.0% - Referenced as a comparable high-frequency tracking model. Eurozone Q1 GDP growth: 0.3% - Positive but weak, setting up recession concerns for Q2. Eurozone inflation (June): 8.6% - Year-over-year inflation, up from 8.1% in May. Estonia inflation: 22% - Used as an example of severe inflation in the Baltics. France inflation: 6.5% - Lower than many peers due to subsidies and nuclear power. European gas storage: 57% full - Current storage level, with EU target of 90% by Nov. 1. Nord Stream 1 pipeline flow: about 40% of capacity - Illustrates reduced Russian gas flows into Europe. European gas price: 145 euros per megawatt hour - Compared with about 25 euros a year earlier. U.S. Henry Hub natural gas price: $6.50 per MMBtu - Roughly double the prior year, though far below European levels. U.S. gasoline price guess: $3.57 per gallon - A lower wholesale gasoline price cited as a sign retail gas prices may fall soon. Copper price: $3.57 per pound - Used as a recession-sensitive commodity indicator. 5-year, 5-year forward inflation expectation: 2.04% - Ryan’s statistic of the week; peaking near 2.6% in April. Euro area 5-year, 5-year forward inflation expectation: about 2.1% - Gaurav said European bond markets do not show major long-term inflation fear. U.S. 10-year minus 2-year Treasury spread: 3 basis points - Near-flat yield curve, seen as signaling slowdown without outright inversion at that moment. High-yield credit spread: 550 basis points - Approaching the 2018 level when the Fed pivoted to a more cautious stance. U.S. initial jobless claims: 231,000 - Recent claims level, still below levels typically associated with recession. Equilibrium jobless claims estimate: 250,000 - Ryan’s rule-of-thumb threshold for a stable labor market. U.S. recession odds: 40% next 12 months; 60% next 24 months - Mark Sandy’s updated assessment. U.S. recession odds: 45% next 12 months; 65% next 24 months - Ryan Sweet’s assessment. U.S. recession odds: 40% next 12 months; 60% next 24 months - Chris Christarides’ assessment. Europe recession odds: 50% next 12 months; 60-65% next 24 months - Gaurav Ganguly’s assessment for Europe.

Pivotal Quotes: "The revision was small overall for total GDP... but there were some enormous revisions to consumer spending." — Ryan Sweet: Explaining why the Q1 GDP headline looked modestly changed even though the underlying composition shifted materially. "If Russian supply ceases completely and Europe can't sort out alternatives, then I think we're in for a very rough time." — Gaurav Ganguly: Summarizing the main downside risk to Europe’s economic outlook. "The bond market's saying that they're going to pull it off." — Ryan Sweet: On inflation expectations and yield-curve signals suggesting central banks may achieve a soft landing.

Implications: Listeners should watch energy prices, gas storage, and labor-market data as the next key recession signals. Europe looks more fragile than the U.S., but both may avoid a severe downturn if inflation eases and commodity shocks don’t worsen.