Aurelia Butler

The energy stand-off between Russia and Europe is reaching high noon. The Kremlin last week shut down indefinitely its main westwards gas pipeline, Nord Stream 1, cutting total Russian gas flows to a fraction of prewar levels and sending prices surging. Vladimir Putin’s calculation is that European countries will prove less able to bear soaring winter energy bills and possible shortages than Russia can withstand western sanctions — and that their unity and resolve will shatter before the spring brings renewed military offensives in Ukraine. With Kyiv’s forces starting to make breakthroughs, the coming energy battle is one that democratic Europe cannot lose.As the EU thrashes out its joint response, there is cause for guarded optimism. Ursula von der Leyen, European Commission president, says Russian gas has fallen from 40 per cent of EU gas imports before the war to 9 per cent today. New suppliers of liquefied natural gas have been found, fuel sources switched and efficiency measures brought in. The EU’s gas storage is 84 per cent full — higher than the 80 per cent target it set for the end of October.Prices, though volatile, have dropped below the level before the Nord Stream 1 closure was announced. Some analysts dare to whisper that, having already fired his main gas weapon, Putin may have limited ammunition left.Yet there can be no false sense of security. Russia’s NS1 closure makes the winter recession that has loomed over the eurozone an ever-growing reality. The already high risk of rationing and blackouts has increased, and a harsh cold snap could quickly drain gas stores. Not all countries will be affected equally: those traditionally most reliant on Russian gas, including Germany, Italy and central European nations, face a deeper economic downturn, which could impose strains on solidarity.Super-high prices are still crushing households and industrial production, and higher interest rates will exacerbate the squeeze. Without robust action, German officials warned earlier this year of the potential for an “ice-cold winter”, and thousands left out of work in industries that shut down, never to reopen. Progress has been made since then, but social unrest from the cost of living squeeze — as exemplified by recent protests in the Czech Republic — remains a risk. EU nations will be under pressure to spend even more to prevent such dislocation and avoid a backlash against the privations being demanded in the name of solidarity with Ukraine.This makes the co-ordinated EU approach — which von der Leyen is due to outline on Wednesday — all the more critical. So far, countries have responded with varying policy prescriptions, including price caps, one-off payments and subsidised transport. Some €350bn has already been spent and pledged, stretching public finances. Agreeing a joint plan will not be easy. Splits remain over plans for a gas price cap and mechanism to capture windfall profits. But the spirit of co-operation, within the EU and with other international partners, is the only way forward.The higher gas demand remains and the tighter the availability of alternative supplies, the stickier high inflation will be and the deeper the economic costs for the whole bloc. Joint demand and supply management will now be crucial; proposals for common efforts to cut power use and facilitate liquidity to energy companies are laudable.These will need to be combined with efforts to strengthen energy infrastructure to help balance supply and demand, and co-ordination to prevent hoarding of supplies. Europe has held its ground well so far. But the economic war with Putin will finally be won or lost on how well the bloc can stick together. More

Inflation delivered a double helping of doom for consumer industries on Tuesday. UK food delivery group Ocado and Fever-Tree, which makes tonic water, both said rising energy costs would hurt their numbers.Inflation is hitting consumer businesses differently as it works its way through the system. Cost pressures are easing as economies slow, but patchily. Some agricultural commodities are near normal levels. Energy prices are falling, but remain historically steep.The fatter margins of brand holders cushion them better than the slim pickings retailers characteristically receive. Both factors put Fever-Tree in a stronger position than Ocado Retail, the delivery group’s joint venture with Marks and Spencer. The mixers specialist will meet profit expectations for the year. Ocado Retail will merely break even.Shares in parent Ocado fell more than a tenth. It is heavily exposed to higher energy prices and the soaring cost of dry ice used to transport frozen goods. Together they may add as much as £45mn to group costs this year, wiping out the bulk of earnings from a top line of some £2bn. Sales are expected to fall for the first time this year as consumers trade down and reduce the size of their shopping baskets from pandemic-era levels. Rising gas prices hurt Fever-Tree by increasing the costs of glass bottles. It said gross margins were 6.7 percentage points lower in the first half of the year. But it is managing to offset this with lower transatlantic freight costs as US capacity ramps up. A scarcity of workers is the biggest hurdle to that endeavour.Both groups are still growing. Analysts expect sales at Fever-Tree to end the year 15 per cent higher. Customer numbers grew 23 per cent to almost 1mn at Ocado. Capacity additions will add 200,000 of weekly orders to a total of 374,000 in the third quarter. Unfortunately, inflation and higher interest rates are lowering the value of future earnings. Shares in both businesses have lost at least half their value over the past year. Fever-Tree’s earnings multiple is at 20 times compared with a long-term average of 35.Consumer groups have little choice but huddle in the corner and take the beating markets are dishing out. Tough economic conditions and weak stock markets will persist for months to come. More

Serbia has turned to the IMF and the United Arab Emirates for help in handling its soaring debt costs in a move that highlights the impact of higher interest rates and the economic downturn on Europe’s emerging markets. The IMF on Tuesday confirmed to the Financial Times that Belgrade had called for discussions on a so-called standby arrangement. Such an arrangement would allow Serbia to draw on IMF support in the event that Belgrade could not sell its bonds to investors. Authorities hope that having the Fund’s assurances in place will prevent further rises in the country’s borrowing costs on international markets, which have more than tripled since the turn of the year from less than 2 per cent to more than 6 per cent. “You don’t want to have a standby arrangement with the IMF if you’re a stable country but maybe it’s better to eat humble pie now to make sure you are not refinancing at more than 6 per cent,” said Tamara Basic Vasiljev, senior economist at Oxford Economics. News of the IMF request comes after Abu Dhabi offered Serbia a $1bn loan at 3 per cent. “If we were to enter the financial market, it would cost us at least two-and-a-half times more,” said Aleksandar Vučić, Serbia’s president, in a statement published on Monday, adding that Belgrade was facing “resistance by all investors, because it’s mostly western financial investors”. Serbia is one of several countries in central and eastern Europe, including Hungary and Romania, that have seen their borrowing costs soar on the back of the US Federal Reserve’s and the European Central Bank’s sharp increases in interest rates. The country’s most liquid euro-denominated bond was trading with a yield of 6.3 per cent on Tuesday, compared with 1.8 per cent at the end of last year. While financing costs have risen across Europe, riskier borrowers — such as Serbia — have seen yields soar at a far faster rate. The gap between Serbia’s yields and those of Germany has widened, from 2.2 percentage points in January to just under 5 percentage points. Credit rating agencies have warned Belgrade that its government and banking sector are exposed to funding risk owing to a high share of foreign currency loans. The economic outlook is becoming more downbeat. Its central bank believes a downturn in the eurozone, Serbia’s biggest trading partner, is likely to weigh on growth, while the war in Ukraine has triggered a rise in inflation to 13.2 per cent in the year to August. Serbia has also become more politically isolated from the rest of Europe since the onset of Russia’s invasion after it refused to join western sanctions against Moscow. The European parliament in its June report on Serbia urged Belgrade to “reassess its economic co-operation with Russia”.Vučić, who was re-elected for a new term as president in April, insists on keeping diplomatic channels to Moscow open even as Serbia continues to angle for eventual EU membership.Abu Dhabi is already a major investor in Serbia, with UAE companies holding a stake in the national airline and developing a $3.5bn mega-project on the Danube riverfront in Belgrade.

Discussions with the IMF will continue in the coming weeks. The IMF and Belgrade will assess the economic and financial situation and determine the size of the country’s overall financing needs as well as an appropriate policy response, the Fund said. Serbia agreed a three-year, $1.2bn standby arrangement with the Fund in February 2015 but did not draw on it. More

Economists thought US inflation would keep slowing in August as energy prices fell. But shelter costs didn’t co-operate, so it’s time to break out the tin hats.US equity markets are a sea of red on Tuesday morning, with the Nasdaq down around 3.5 per cent and the S&P 500 off 2.8 per cent around 11am.

Is this good? © Finviz

The real mess is happening in the rates market, however. This correspondent is old enough to remember when it was notable to see the 2yr yield rise above 2 per cent. Now we’re up ~17bp at 3.7 per cent, with the 10-year trading at 3.4 per cent.

It’s been a long few years. © Refinitiv Eikon

Futures markets are pricing in a 75-basis-point rate increase at next week’s Fed meeting, via CME’s FedWatch.One silver lining here is that, even with the White House talking about inflation being “essentially flat” over the past two months, there are more interesting topics here. Economists and pundits like to say that Americans are especially sensitive to gas costs, but the unexpected strength in food and shelter costs are not especially helpful for the argument inflation has peaked. For a further breakdown, here are a couple of nice inflation heat maps from our pals at CreditSights. First the year-over-year:

And now for the monthly figures:

This is probably bad news for corporate credit markets, as the firm’s strategists write: If a 75bp increase by the Fed at the [September] meeting was not a given prior to today’s release, it surely is now. The Fed fund futures market is now pricing in a small possibility of a 100bp hike. We think the Fed is now locked in for 75bp . . . This is a negative development for corporate credit as any hopes of a dovish shift by the Fed have been dashed. The Fed is now expected to raise rates above 4 per cent in early 2023 this hiking cycle, futures markets show. In other words, interest costs are going up for even the safest borrowers (at least those who have to refinance this year or next). LQD, the biggest investment-grade corporate-bond ETF, is down around 0.9 per cent. The silver lining? We won’t have to lose any time or brain cells reading arguments about basic arithmetic from people trying to describe what happened with inflation. More

Over the next few months, you and your computer code can hatch a plan to save a planet. It’s a fictitious artificial planet, granted, but one that simulates the economy, geopolitics and climate of our real world. And perhaps your ideas will soon prove useful here on warming Earth.Launched last month, AI for Global Climate Cooperation is a competition organised by Mila (an artificial intelligence institute in Quebec) and Salesforce Research. The group, working at the intersection between AI and economics, is soliciting submissions in the form of novel climate agreements and negotiation protocols.Academic economics is generally a conservative enterprise, but AI is slowly beginning to seep in. Instead of writing down and solving trusty formal mathematical models, with the assumptions and difficulties they carry, AI may allow economists to throw all their ingredients into a simulated stew and find out how it tastes.When it comes to saving the planet, these ingredients will be plugged into “a multi-region integrated assessment model” called RICE-N, calibrated to the latest real world data. Each proposal will change the simulated world in some way, as its AI agents go about their self-interested business. The fictitious temperature will be checked and winners will be declared. But that’s not where the work will end.“That competition is just a vehicle for the community to quickly try out a lot of new solutions,” said Stephan Zheng, a research scientist at Salesforce and a contest organiser. If the work passes ethical and peer review, “we can start thinking about communicating those results to the policymaking world, to the actual climate.”“We can do things that are hard to do analytically,” said David Parkes, a member of the competition’s jury. “Economic models tend to be highly stylised — maybe with AI we can get closer to the real problem.”The real economic problem in this instance is climate change. But a similar approach could shed light on other knotty challenges for economists — tax policy, contract design, trade deals or the supply chain.The advantages are many. AI agents might be able to do some of the dirty work for us, playing out our proposals to their conclusions. They also mean that if we mess things up, we won’t cause our own extinction. Let the simulation wrestle with the tricky business of geoscience, meteorology, macroeconomics, international politics and national interests.AI for Global Climate Cooperation (perhaps an algorithm could invent a snappier name) builds off the earlier AI Economist project, in which AI citizens wander around a simulated two-dimensional digital world of houses, coins, wood and stone. An AI government keeps a watchful eye, aiming to maximise productivity and equality, learning as it goes about the behaviour of its digital constituency and responses to new policies such as a changes in the income tax rate.There are hopes that the growing influence of AI in economics might also address a trio of nagging difficulties in the field. The first is the sheer number of people that exist, with all their different interests. For tractability, economists often assume the existence of a Platonic “representative agent”, or simply elide the fact that many real people make up the real world. With enough computational power, perhaps you can simulate them.Second are the logistical, political and financial barriers that exist when it comes to experimentation. It’s not often feasible to test a pet tax policy, social program or international agreement in the real world. But it’s easy enough to change the laws and parameters of an artificial planet.The final hurdle is a conundrum at the heart of game theory. Just because an agreement is great for the collective, or the climate, doesn’t mean that individual actors will adhere to it — the central result of the prisoner’s dilemma. No single authority can enforce the optimal deal, so successful agreements — climate agreements included — must be upheld through a scaffold of supporting incentives. Perhaps a simulation can test many of these possible scaffolds without the risk of the whole thing falling apart.But AI cannot solve the most crucial problems in economics — or anything else — on its own. The most interesting problems are multidisciplinary and require wisdom beyond the models and algorithms. And eventually real people will need to shake hands, sign agreements and pass laws. At some point, the humans will need to get [email protected] More