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Stagflation risks keep rising

The past week added more signs that we could be heading for a stagflationary environment with weakening economic activity amid more persistent inflation pressures. New pockets of inflation keep popping up as supply side challenges continue. European gas prices shot higher again this week reaching six times the normal level. Comments from Russian President Vladimir Putin that indicated the country was prepared to help stabilize the market sent prices lower on Wednesday, but gas prices are still five times higher than before the prices started to soar. Oil prices also increased further this week to above USD80 per barrel. If these pressures persist we could see Euro inflation stay at high levels over the winter and continue to erode purchasing power of consumers, see Research Euro Area -” Looming energy crisis creates a perfect storm. Other prices that have shot higher has been cotton (up 25% in a month) and coal (up more than 200% the past year).

Labour shortages also continue to be a challenge in most countries. In Asia, thousands of migrant workers employed in city factories are returning to their villages after lockdown measures have been lifted, adding to bottle necks in production. And in UK a lack of truck drivers have led to severe shortages of many goods, not least gasoline.

On the activity front, German data on orders and industrial production disappointed this week. Orders dropped 7.7% m/m and industrial production plunged 4.0% m/m. Supply chain issues in the car sector are still an important factor for the weak industry performance, but signs of weakening demand in survey indicators suggest that more downside might lie ahead for Q4. On a more positive note, the US ISM manufacturing index increased in September and is still at a high level. Our leading indicators suggest it is a matter of time, though, before it starts declining, see Top 10 global cycle indicators, 4 October 2021.

After falling risk sentiment last week, markets have stabilized somewhat this week. Positive news on the US debt ceiling supported sentiment. Republicans and Democrats in Congress opened the door to a temporary solution to the debt ceiling issue, saying they would consider a stop-gap measure extending the borrowing limit until December. The Evergrande crisis has also calmed down somewhat, although the underlying problem is unresolved, see Research China -” No ‘Lehman moment’ but financial stress is not over. In other news, President Biden stated that he has confidence in Fed Chairman ‘at this time’ suggesting that Powell will be reappointed later this autumn.

EUR/USD continued to drop this week as challenges continue in the euro area with weakening data and upward pressure on inflation from gas prices. We look for a further decline in the cross over the coming months.

Next week, focus turns to US data on CPI inflation and US retail sales. Consensus on US core CPI inflation is another muted increase of 0.2% m/m (was 0.9% m/m three months ago). In Europe we get the German ZEW, which has nose-dived lately, and UK monthly GDP. Developments in gas and electricity prices will also be in focus. In China, keep an eye on the property crisis data on credit. Finally, IMF publishes new forecasts on Wednesday. 

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