An EU/US natural gas spread to push the euro below parity?

100 euro banknote on a gas burner. The concept of the cost of natural gas and the energy crisis in Europe – Photo: Leka Sergeeva/Shutterstock

Since the beginning of the conflict between Russia and Ukraine, Europe has been hit by the worst energy crisis in its history, with the price differentials of European (Dutch Title Transfer Facility) and American (Henry Hub) natural gas widening at record highs and the EUR/USD currency pair is getting dangerously close to parity levels.

According to the most recent data from CME Group, US hub Henry spot prices are currently trading at an equivalent discount of $57/MMbtu to the Dutch TTF benchmark in Europe as of mid-August 2022.

The link between EUR/USD and the Henry Hub-TTF spread has increased significantly over the summer, with the rolling 90-day correlation coefficient reaching 0.79. This basically tells us that the lower US natural gas prices are relative to Dutch European TFF prices, the greater the downward pressure on the EUR/USD pair.

From a macroeconomic perspective, the Russian gas crisis is likely to cause a more severe economic downturn in Europe than in the United States. The widening TTF-Henrty Hub gas price differential makes European companies less competitive than US companies in terms of input costs and also reduces real wages and household incomes in Europe more than in the United States. United

Has the market correctly priced a recession in Europe due to the energy crisis? If so, has EUR/USD bottomed out? Or can the gas crisis get even worse, causing the pair to break below the parity level?

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Chart to Watch: EUR/USD is pegged to the Henry Hub-Dutch TTF Natural Gas Spread

a chart showing the EUR/USD and Henry Hub Dutch ttf price spreadEUR/USD vs Henry Hub-Dutch TTF Price Gap and Correlation Analysis as of August 16, 2022 – Photo: / Source: Tradingview

EUR/USD Macro Outlook: Will the Euro fall below 1.00 due to the fall in the EU economy?

a graph showing the fall of Germany's ZEW Economic Sentiment Index in August 2022,

Germany ZEW Economic Sentiment Index in August 2022 – Photo: / Source: Tradingview

a chart showing diverging trends in the trade balance of the Eurozone versus the United States

Eurozone trade balance vs United States (rolling comparison over 1 year to August 2022) – Photo: / Source: Koyfin

a chart showing diverging trends in the eurozone versus US wage growth

Eurozone vs US: real wage growth – Photo: / Source: Tradingview

The gas crisis in Europe is wreaking havoc on the Eurozone economy and this effect has already been quite visible on the EUR/USD trend in 2022.

The ZEW Economic Sentiment Indicator for Germany, one of the main forward-looking indicators for eurozone GDP growth, fell to -55.3 in August 2022 from -53.8 in July and below market expectations of -53.8. This is the lowest figure since October 2008, when the Great Financial Crisis began.

The persistent trend in inflation and the anticipated increase in heating and electricity costs during the winter continue to weigh on the economic outlook for the euro zone. So while the US inflation rate may have peaked, Europe is still a long way off.

The US, a major oil and gas producer, has not seen the same energy price increases as Europe, as evidenced by the Henry Hub-TTF natural gas spread. In the absence of Russian gas, Europe has increasingly imported liquefied natural gas (LNG) at higher prices from the United States and other suppliers.

As a result, the euro area’s trade balance deteriorated sharply, with a deficit of €200.7 billion in the first half of the year, compared to a surplus of €83.2 billion in the same period of the year. former. The US trade balance is also in deficit, but has improved in recent months, helped by soaring energy exports.

If we consider the growth dynamics of real wages in the euro zone – a key indicator for forecasting the evolution of real household incomes and consumer spending – we are currently at the lowest level on record (-6, 2%). This will have a negative effect on consumption in the euro zone this winter. In contrast, nominal wage growth in the United States always exceeds inflation, which translates into positive real wage growth.

In summary, Europe is more directly affected by the natural gas crisis than the United States, and it is highly likely that Europe will continue to experience higher inflation and slower economic growth for an extended period.

EUR/USD forecast: what to expect next?

Investors have already been quite bearish on the EUR/USD pair this year, mainly due to the widening interest rate differential between the Federal Reserve and the ECB.

Along with economic growth and interest rate disparities between the two regions, the more severe natural gas crisis in Europe relative to the United States is now a key macroeconomic factor affecting the EUR/USD exchange rate. .

Traders should then closely watch the Dutch TTF/Henry Hub spread as a key indicator of supply disruptions in the European and US gas markets.

If the gas crisis in Europe worsens in the coming months, the price differential between Dutch natural gas TTF and Henry Hub could widen further, which would probably push the EUR/USD pair below the parity threshold. .

A de-escalation of the Russian-Ukrainian conflict, coupled with a drop in the price of Dutch TTF gas, will be a key factor in preventing a further depreciation of the single currency. However, this scenario seems less likely.

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