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PATRIS Fixed Income Weekly - 12 October 2018

12 Oct 2018

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WEEKLY COMMENTARY

1.US Core consumer prices showed in September a modest rise for the second month in a row. The 0.1%m/m rise recorded last month brought the three-month annualised rate of change to 1.8% in September, from 2.0% in August, suggesting weaker underlying inflation pressures in recent months. The weakness in September was concentrated in goods prices, while services inflation remains solid. In annual terms, core inflation remained at 2.2%. The strong US Dollar continues to be a risk to inflation over coming months. However, wage growth is likely to continue to put upward pressure on prices in the services sector. Despite the pressure on global equities, long maturities in the US have not received much support. The move higher in US bond yields continues to reflect upward revised expectations for the Federal Reserve neutral rate, as well as a higher term-premium, probably reflecting higher interest-rate risk. Further declines in US equity markets are nevertheless expected to push lower UST yields.

2.Moody's (Ba1/Positive) and DBRS (BBB/Stable) may both update its credit rating for Portugal today. Moody's is the only one of the major 4 rating agencies that still rate Portugal as speculative grade. In May, Moody's stressed that Portugal's sovereign rating would be upgraded to investment grade should it conclude that the positive economic and fiscal trends are likely to be sustained, increasing its confidence that the very high debt burden will move to a steady and downward trend. There has been not much contagion from BTPs to Portugal. However, further selling pressure on risk assets may end up pushing Portuguese bond sovereign spreads higher.

3.Italian yields rose across the curve over the week. The Italian government has confirmed its 2019 deficit target of 2.4% of GDP (2.1% for 2020 and 1.8% for 2021). The path that the current government is taking could be even a bigger problem for markets and rating agencies (e.g. the pension reform reversal). Italy will have to submit its budget plan to the EC by 15 October. The Italian 2019-2021 fiscal plans are likely to be considered as non-compliant with EU fiscal rules. The EC and the Italian government will have to find common ground, which could lead to further volatility over coming weeks. For now, there are no signs of contagion to other EGBs markets. The Italian government wants fiscal policy to provide a boost to GDP growth. However, a tightening in financial conditions (via higher sovereign bond yields) may entirely offset the desired boost.

4.The accounts of the September ECB MPC meeting were released yesterday. The accounts showed a discussion focused on external risks and weaker global trade. There was no news about the reinvestment policy. ECB members noted the pick-up in wage growth, namely in those countries where the business cycle is more mature, reflecting the tightening labour market. However, the accounts also mentioned that ECB officials recognise that the transmission of higher wages to CPI inflation remains uncertain.

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