La Niña’s Blues and Natural Gas
Natural gas has been in exceptionally short supply all summer, with prices reaching record highs in August. However, with European gas reserves now full and an unseasonably warm autumn so far, prices have tumbled by 62.5%. Such volatility has been a major headache for policymakers who are fighting inflation on many fronts. But they may well receive a boost from the one factor most responsible for demand – the weather.
The temperature in Europe is to a large extent dictated by the flow of the jet stream – a current of warm air which begins around the Gulf of Mexico and traverses the Atlantic before making landfall in western Europe. The flow of the jet stream is impacted by the La Niña/El Niño effect, which has its origins in the Pacific Ocean. Because of the Earth’s rotation, warm water pools in the Western Pacific, towards Australia and Asia, and deep colder water comes to the surface in the Eastern Pacific, towards the Americas. When this pattern breaks down, and the Eastern Pacific warms we call it an El Niño event. When this pattern intensifies, we call is a La Niña event. A La Niña can occur predominately in the far Eastern Pacific or in the Central Pacific. Depending on where the La Niña forms different global weather patterns take shape. We are about to enter a third La Niña event, which forecast models show to be following the patterns of a Central Pacific La Niña. Such events can cause warmer, drier winters in Northern Europe with stormier conditions in Southern Europe. While the strength and location of the cycle varies, this should mean a relative warm winter in Europe, with the caveat that occasional fronts of air can and do push down from the arctic to create a cold snap if the polar vortex weakens.1 Taken in tandem with currently full reserves, it may well mean that policymakers have got lucky – and that the gas price will continue to fall.
However, La Niña has implications for other commodities as well, particularly soft and agricultural commodities. With much of Europe’s fertiliser production shutdown over the summer due to high natural gas prices, we could well see easing of various agricultural commodities as production returns, increasing yield both for winter sowings and those planted next year. Moreover, drought relief will also be a boon to crops in southern and central Europe.
Figure 1. Oceanic Niño Index – 1990-Present
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Source: National Oceanic and Atmospheric Administration; as of 30 September 2022.
Hey, Hey, BoJ, How Many JGBs did You Buy Today?
As global rates rise, attention once again turns to Japanese bond markets. Yields on 10-year Japanese Government Bonds (‘JGBs’) have been capped at 25 basis points (‘bps’), with JGBs trading at or close to the cap for most of the year (Figure 2). The Bank of Japan has aggressively purchased bonds, thus keeping the cap roughly in place, even though yields for non-targeted maturities have now become dislocated from those selected for purchase (Figure 3).
The continuation of yield curve control presents its own problems. If yields are capped, it makes little sense for bondholders to sell targeted maturities – there is after all only one willing buyer, who effectively sets a price floor. We are already seeing reduced liquidity as consequence: the BoJ owns more than 65% of 10-year JGBs, and with global yields rising, it is unlikely that the figure will go down. We are already seeing signs of stress in the futures market, with the 10-year JGB price spiking repeatedly above the capped yield – albeit at stress levels lower than those seen in June (Figure 4).
In our view, reports of the death of yield curve control are greatly exaggerated. Without yield curve control, the entire JGB yield curve would undoubtedly be much higher. Yields for target maturities are at the limit of tolerated ranges, but have not consistently breached them. In that sense, the policy is still working.
But in the wake of a 75 bps rate hike by the Fed, we do not expect yield curve control to persist much longer. The interest rate differential to the dollar is simply too large, weighing not only on JGBs but also the yen. Japan is a major energy importer: a weakening currency in an inflationary environment will only further contribute to stress on the Japanese consumer. Yield curve control may not have failed, but its future hardly seems bright in the land of the rising sun.
Figure 2. 10-Year JGB Yields
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Source: Bloomberg; as of 4 November 2022.
Figure 3. Japanese Yield Curve
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Source: Bloomberg; as of 4 November 2022.
Figure 4. 10-Year Yields Versus 10-Year Futures (Inverted)
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Source: Bloomberg; as of 4 November 2022.
With contributions from: Matt Goldklang (Climate Scientist, Man Numeric), Oliver Whitehead (Head of Investment Risk, Man AHL)
1. Oceanic Niño Index (ONI), NOAA.
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