Centerfin Collective Weekly

Week ending Sept 16, 2022

This week: European energy situation, Ukraine counter-offensive, stubbon inflation data, and the ETH merge

Our Commentary

European energy situation

Following years of misguided energy policies in Europe, we are finally seeing some of the adverse effects. Energy prices have skyrocketed across the European continent, causing hardship for people and businesses. As a result, we have begun to hear about price controls designed to alleviate the pain. We don't believe this is a good idea, as any subsidies on energy prices would have to come from the government and, ultimately, the taxpayer. Subsidies also do nothing to help dampen demand, hence no natural downward pressure on inflation.

In addition, this environment has put pressure on existing leadership. In the UK, Boris Johnson was forced to step down in early July. Italy was next, as Mario Draghi stood down later that month. And just this week, the existing Prime Minister of Sweden was defeated in their election. We highlight this because, in every one of these cases, the new government seems to be politically right of center. In the UK, Liz Truss became the Prime Minister last week. Within days of coming to power, she announced sweeping changes to the country’s energy policy, including subsidies for families and businesses and loosening regulations for drilling for new sources. We expect to see more of these types of policies from the newly elected leadership. We also note that right-leaning politicians tend to lean toward nationalistic and protective policies, something to keep in mind as the power dynamic between the West and East is re-balanced.

Ukraine counter-offensive

By many accounts, the Ukrainian army has staged an impressive counter-offensive effort to retake some areas north and east of Kharkiv. While this is hopeful news, given both sides' propensity for propaganda, we must take this with a grain of salt. If true, we would be concerned about whether this puts Putin in a difficult position. We find it hard to believe that Putin would accept defeat in this conflict. Hence, we are concerned that this causes Russia to escalate with the potential use of nuclear weapons.

Stubborn inflation data in the US

This week the consumer price index (CPI) came in hotter than expected. Substantial increases in shelter, medical, and food prices outweighed lower energy costs. The equity markets fell hard on the news as the market re-priced rate hike expectations. The market now expects the Fed to raise 75 bps next week and the terminal rate to reach above 4%. Given the lag between interest rate rises and the downstream effects, our concern is that the Federal Reserve tightens too much and causes a deeper recession than intended.  

The Ethereum Merge

Ethereum, the second largest cryptocurrency, successfully completed its widely anticipated conversion to a Proof of Stake consensus mechanism this week. One of the significant criticisms of Bitcoin is that its Proof of Work consensus mechanism is slow, expensive, and uses too much energy. Proof of Stake conceptually addresses this. Crypto is one of the most popular topics of conversation we have with clients. We maintain that this is a potentially game-changing space, but it is still very early in its life cycle. The conversion of Ethereum from Proof of Work to Proof of Stake is a significant feat. It is akin to changing the engine of a plane while in mid-flight. That said, we would like to see how things develop from here before adjusting our perspective.

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