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Euro Weekly Fundamental Forecast: Bearish

• Ukraine and Moldova recommended for EU candidacy while Georgia requires further reforms.
• Apparent ‘technical issue’ results in Germany, Italy, and France among those receiving less gas than requested from Russia.
• The ECB’s unsubstantiated mention of bond anti-frag tool results in rising bond spreads – emergency meeting called to redirect APP reinvestments to problem areas.

Source: TradingView, prepared by Richard Snow

EU Welcomes Ukraine and Moldova as Candidates for EU Inclusion

EU Commission President Ursula von der Leyen welcomed Ukraine and Moldova’s candidacy as the two nations hurriedly applied for membership soon after Russia invaded Ukraine. While the process can take years to complete, the nations are a step closer to living "the European dream.”

President Voldymyr Zelenskiy tweeted, "It's the first step on the EU membership path that'll certainly bring our victory closer." Georgia, which also applied for EU membership, was not yet recommended as a candidate as it is said to have to meet more conditions.

EU-Bound Gas via Pipeline Falls Short of Required Flows

Germany, Italy, France, and Slovakia are among the nations that received significantly less gas than requested via the Nord 1 pipeline. Italy and Slovakia reported less than 50% of their usual volumes. Germany reported receiving 60% less gas from Russia than was agreed. The Nord 1 pipeline accounts for 40% of Russian pipeline supply to the EU.

The shortage has been viewed skeptically by Italian Prime Minister Mario Draghi, accusing Russia of using its gas supplies for political reasons. Russia pinpointed the issue to the slow return of equipment that was sent to Canada for maintenance.

The shortage comes at a rather inopportune time as the south of Europe experiences a heatwave, demanding greater gas for cooling. In addition, Europe is crucially in the process of storing gas for the cold winter period, and the amount currently lags the 5-year average.

Gas shortages and rationing is a topic that surfaced during the early stages of the war, and it could hamper the Eurozone economy (and the euro) if such drastic measures were needed to be implemented.

ECB Tight-Lipped on Anti-Frag Bond Tool, Emergency Meeting Required

ECB President Christine Lagarde mentioned a special anti-fragmentation tool that is ideally going to reduce bond market volatility as the Bank raises interest rates. However, when asked about it, Lagarde elected not to give any specifics, which resulted in the very undesirable moves in the bond market that the Commission sought to avoid.

In an attempt to address unwarranted moves in the bond market, The ECB called an emergency meeting with many speculating that the Governing Council would reveal the aforementioned tool. Instead, the Governing Council agreed to direct APP reinvestments to the markets that require the most attention. A portion of the statement reads as follows:

“The Governing Council decided that it will apply flexibility in reinvesting redemptions coming due in the PEPP portfolio, with a view to preserving the functioning of the monetary policy transmission mechanism, a precondition for the ECB to be able to deliver on its price stability mandate.”

The riskier Italian bond (BTP) and safer Germany Bund spread has been created below, revealing a general uptrend culminating in the spike after the June 9 ECB meeting. Bond yields in the EU’s periphery nations: Portugal, Italy, Greece, and Spain in particular, may well experience rising spreads as the ECB attempts to hike in July and September.

BTP, Bund Spreads Blowout in Response to Tight-Lipped ECB

Source: TradingView, prepared by Richard Snow

Markets have priced in a 25 bps and 50 bps hike by September, meaning that July’s standard 25 bps hike is likely to go ahead with markets anticipating a worsening inflation outlook, justifying a 50 bps hike in September.

Implied Market Expectations via Money Markets

Source: Refinitiv

Major Risk Events Next Week

Scheduled risk events are fairly quiet compared to the bumper week that has just passed, where we saw movement from 2 out of the 3 major central banks alongside other significant sentiment data.

Next week we see EU consumer confidence alongside German and EU PMI flash data for June, as well as the European Council Meeting. On Friday, we look to round up the week with the Ifo business climate report.