The European Outlook Darkens: 2024 Recession? 💰

🐺 Hi pack-mates,

This is Howling Markets, the experienced driving instructor teaching you how to race in the financial markets’ track!

Today we will be covering:

•  What Are Interest Rates Swaps? 📈

• Oil Supply Shock: US Production Skyrockets 🛢️

• The European Economic Outlook Darkens: Potential 2024 Recession 💰

• Equity and Debt Markets Weekly Update ⚖️

• And more!

What are the Interest Rates Swaps? 📈

In their simplest form, interest rates swaps are forward contracts in which two parties agree to exchange a fixed rate for a floating.

A forward contract means that it is an agreement about the future, with no payment at the time the agreement is reached.

A vanilla, meaning in its simplest form, interest rate swap contract is defined by two future dates, a fixed interest rate and a floating rate.

If we imagine to be at a time “zero”, and that in the future there are two dates, date S and date T, with T coming after S, we can define a vanilla interest rate swap from S to T where at time T the payer will pay the fixed rate to the other party and receive the floating one.

Because the floating is determined from S to T, while we sign the contract at time zero, interest rate swaps are based on the expectation of future interest rates.

If we expect that interest rates in the future will rise higher than the fixed rate offered at time zero, then we will be the payer in the contract, meaning that we will pay the fixed to receive the floating interest rate.

This characteristic of interest rates swaps, paired with the fact that interest rates always move in accordance with the central bank rates, are crucial to determine investors’ sentiment and future policy rates expectations as we will see after the next interesting news.

US Oil Production Skyrockets 🛢️

Well, we unfortunately all remember the coronavirus era with the lockdowns and recessions all over the world. During this period, the worldwide economy was hit by an alarming decrease in production which caused a recession and demanded significant central bank subsidies to keep the economy afloat.

Among the most hit categories, before even inflation really picked up, oil and gas prices skyrocketed. Then, as soon as they started to come down once again, a geopolitical conflict made sure to keep oil prices high, first with Russia and Ukraine, now also with Israel and Palestine.

However, now that all these shocks have been priced in, the oil market got hit once again, but in the opposite direction. The United States, the first oil producers in the world, have reached the highest level of production ever, recording an increase in oil and gas production by 40% over the past three years.

This year, according to the Financial Times, the US pioneered more than 80% of the worldwide expansion in the supply of oil, and all this optimism led to substantial changes in the market structure in the oil sector.

Namely, Exxon decided to buy Pioneer for $60 Billion, while Chevron is investing $53 Billion on Hess forecasting an increase in oil demand.

On the other hand, we should keep in mind that this substantial increase in oil supply and the following decrease in price might lead to a decrease in investment and a slight increase in prices as the optimism wears off.

Today’s Howling Question

We talked quite a lot about gold in the last newsletter, and we noticed that last Thursday, gold’s price fell after reaching a resistance zone slightly below its all-time high. What do you think happened next?

a) Gold’s price came back up, surpassed the strong resistance level achieving its all-time high and then it came back down.

b) Gold’s price came back up, surpassed the strong resistance level achieving its all-time high and then it continued to increase.

c) Gold’s price kept falling after last Thursday’s retracement.

d) Gold’s price increased but did not manage to break the resistance level, so it continued to move sideways throughout the week.

e) Gold’s price increased but did not manage to break the resistance level, going back down once again.

Hint: Here is gold’s price chart, but I have removed the candles after last Thursday’s. In the answers, after the last interesting news, you will find the complete chart!

The European Outlook Darkens: 2024 Recession?

At this point, it has been almost 2 years since most financial experts started calling for a recession. You know what they say, even a broken clock shows the right time twice a day…

In reality, most recessions do not occur when the central banks start raising interest rates, but rather they occur when central banks start reducing rates.

This is because it often happens that central banks start to drop interest rates only when they see a significant slowdown in economic activity and a reduction in inflation, however such a reduction also comes with a reduction in GDP.

Over the last three inflation readings in Europe, the result has been characterized by a downward surprise, meaning that inflation had decreased more than expected, and it is now currently sitting almost at the ECB’s policy target.

The issue with this European monetary policy is that the increase in rate has been way too rapid for an inflexible environment such as Europe, where rates and inflation hardly fluctuated over the past 20 years.

Just to put things into perspective, the ECB started increasing rates well after the Federal Reserve, but they achieved their goal sooner and they are looking to decrease rates earlier.

However, what might seem a great feat of strength, in reality it only risks being an overly aggressive monetary policy. As a result, GDP has already significantly slowed down in the Euro area, and it is expected to keep decreasing at least throughout the first part of 2024.

The swap markets are expecting the ECB to start decreasing policy rates in March, three months before the Feds, but will it be enough to avoid a recession?

Equity and Debt Markets Update ⚖️

And now, our weekly markets update!

Starting from the stock market, the price has continued to move sideways throughout the week. Some days it moved slightly higher, other days slightly down, but with no real consequences.

However, situations like these are extremely important to monitor because when the volatility starts to decrease, it usually means that the stocks are preparing for a large move.

Additionally, in the SPX chart (with 4 hour candles) reported below, it is possible to see how the RSI is dropping while the price is moving sideways. This is a generally bad look for stocks because when the strength that is keeping the price high is dropping, usually prices will follow. This trading signal is called RSI divergence.

On the other hand, despite the fact that the debt market continued to slide down the first days of the week, it started to show signs of upward momentum on Wednesday.

Answer

The correct answer is a) 

Gold’s price came back up, surpassed the strong resistance level achieving its all-time high and then it came back down.

Very surprisingly, gold’s price skyrocketed on Thursday, breaking all resistance levels and hitting its all time high. However, such a move was most likely fueled by a short squeeze due to the strength of the breakout and the fact that it was extremely brief, before coming back down during the following days.

Howl-Worthy Memes

🐺 See you next time!

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