Carbon Divergence, Macro Convergence

Key points:

• Biden’s capacity to circumvent Congress on his green agenda has taken a major hit. The contrast with the European Union (EU) is getting starker, especially after the parliament’s vote on the extension of the Emission Trading System.
• Europe and the United States (US) are converging on the macro slowdown and a less aggressive expected trajectory for central banks.

Until last week it seemed that Joe Biden could salvage his green agenda, despite his absence of majority in Congress on these issues, through his control of federal agencies. What law would not allow, delegated regulation could. This has been dealt a blow by the Supreme Court last week, which ruled that the EPA could not implement its “sweeping change” in power generation in the US without explicit Congressional authorization. Moreover, the Court invoking the “major questions doctrine” may jeopardize many other avenues the Biden administration could have used to circumvent Congress, including potentially on green finance, on which the Securities and Exchange Commission (SEC) had become increasingly involved. The contrast could not be starker with the EU, since the European parliament has voted in favour of the extension of the Emissions Trading System (ETS) and the implementation of a border carbon tax. The legislative process is not over yet – there are still differences with the Council’s positions made public last week- but at least, in Europe all the key political families support the fight against climate change and the need for a price of carbon to emerge. Without a similar level of consensus domestically, the US won’t be able to act as a leader on the world stage on this front. This will impair the chance of success of COP 27 in November.

While the US and Europe are drifting apart on the green agenda, they are converging on the macro data flow: signs of slowdown continue to accumulate, with US consumption showing in May its first clear sign of weakness, and the European Commission survey confirming the message from the Purchasing Managers’ Index (PMI) to suggest a sizeable deterioration in business confidence. The market took notice, with a downward revision in the quantum of policy rate hikes it expects by year end. Fed Funds are now priced under the Fed’s median forecast, and the European Central Bank (ECB)’s depo rate below the “neutral range”. The less aggressive pricing of the central banks’ trajectories is not helping all asset categories though. In fixed income, pressure eased up on investment grade names, but continued to rise in high yield. The impact of rising recession risks trumps the relief from less restrictive monetary policy. The “payroll data” this week will be key.