European shares fell by 20%. Junk loan spreads increase beyond 2020 crisis levels. The euro is sinking.
Forecasts are ominous for financial markets when Russia stops all gas supplies to Europe.
Currently, supplies are running at reduced levels, the main pipeline is closed for 10 days of maintenance and there are concerns about whether Moscow will reopen the tap. Many investors ask how bad can it be?
Answering this question, strategists tried to calculate a scenario that would be unthinkable in normal times. There are so many variables, such as the length of any outage, the extent of supply cuts and how far countries will go to restore power, that any prediction remains a guess at best.
“The big unknown is how the shock that started in Germany, Poland and other Central European countries will affect the rest of Europe and the world,” said Joachim Klement, head of strategy at Liberum Capital.
In an analysis this week, UBS economists laid out a detailed vision of what they see if Russia cuts gas supplies to Europe. This will reduce corporate profits by more than 15%. The market sell-off in Europe will exceed 20% and the euro will fall. The rush for safe-haven assets will drive the German bund to zero returns, they write.
“We emphasize that these projections should be viewed as rough estimates and not as a worst-case scenario,” wrote Arend Kaptein, chief economist at UBS. “We can easily imagine economic disruptions that would lead to more negative growth outcomes.”
Markets are already pricing in some of the damage. The euro is at a two-decade low and is on the verge of dollar parity. German shares have lost 11% since June. German gas giant Uniper is the biggest corporate casualty as it seeks a government bailout.
To be sure, many investors say there is reason to believe that Russia will resume gas supplies when the Nord Stream 1 pipeline ends on July 21. growth will be serious.
“Europe is currently in a vicious circle,” said Charles-Henri Monchaux, chief investment officer at Banque Syz. Higher energy prices are hurting Europe’s economy, depressing the euro. In turn, the weaker euro makes energy imports even more expensive, he said.
A second worry is that central banks won’t be able to do much to help the economy with inflation already at a decade high, said Prashant Agarwal of Pictet Asset Management.
“I’m not sure the central bank tools work in this scenario,” he said. “In the past, they had leeway to deal with the situation because inflation was low.”
