Monetary policy appears to have exhausted itself: the EU is now considering ‘massive’ bond issuance to finance energy and defence spending. Governments in the EU and UK are going to have to foot the bill. They will need to shield consumers and businesses from the sharp increase in energy costs.
The threat of an escalation in sanctions remains. The US is set to announce a ban on Russian crude imports as soon as today. In retaliation, Russia has threatened to cut off gas supplies to Europe.
In the short run, there will be renewed reliance on coal and nuclear in Europe, with plans for the EU to cut Russian gas imports by two-thirds within a year. At the same time, investment in renewables, but also oil & gas production, will have to be accelerated. In an ironic twist of fate, the ESG-compliant move now may be to ramp up capex in oil & gas, to maintain national energy security and allow increased sanctions on Russia. A wave of capital spending, on both oil & gas projects and renewable energy, will push up capital costs further.
The Treasury curve may continue to flatten. But there could be a material shift higher in yields across the board too, as investors balk at government bonds, with increased fiscal spending in the pipeline and inflation pressures persisting.
The self-sanctioning with respect to Russia raises critical questions for investors: where is the line drawn between Russian and Chinese investments? At some point, continued Chinese support for Russia may put China in the firing line. There are now reports that China is engaging in talks to buy or increase stakes in Russian energy and commodities firms. China is stepping in to provide the payments infrastructure for Russian banks too.
