Goldman: Recession Fear Weighing

Goldman Sachs note that “the Euro was the clear underperformer last week, with EUR/USD falling below 1.02 for the first time since December 2002. While recession risks across G10 markets have dominated market discussions in recent weeks, the recent reduction in Russian gas flows has been a reminder that the contours of those risks are quite different. Our economists think a policy-induced recession in the US would likely be fairly shallow, while the political nature of risks in Europe present the possibility of a much deeper downturn. We downgraded our Euro area baseline growth expectations for the next year by about 75bp, while also flagging the risk of a more severe downturn if gas flows from Russia are interrupted entirely. As a rule of thumb, a 75bp growth downgrade is typically worth about 1.5% on EUR/USD, so the moves are consistent with the market adjusting to this shifting outlook and putting some weight on the possibility of an even more significant growth impact. If the market were to move to pricing our severe downside scenario, it could push EUR/USD lower by another 5%. However, we also see room for upside from both a growth and policy perspective. If gas flows resume after maintenance is completed, our metrics suggest EUR/USD could rise by about 1% if the market started to put less weight on these more severe scenarios. In addition, the ECB could choose to respond more forcefully to the inflation risks posed by higher energy prices and the currency depreciation, which would help put a floor under the Euro. Overall, we see the risks tilted towards more downside over the coming weeks, particularly after the strong US employment report that should keep the Fed on the tightening path and somewhat reduce imminent recession concerns in the US.”