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PATRIS Fixed Income Weekly - 19 October 2018

19 Oct 2018

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WEEKLY COMMENTARY

1.In the US, the number of job openings reached 7.136mn in August, a new high for the expansion and the higher reading in the history of the JOLTS report that dates back to December 2000. The job openings data is usually seen as a forward-looking series for the labour market and as an indicator for a turning point in the US economy. The number of job openings has surged in 2018 and posted increases over the last 3 months, suggesting that the US business and labour market cycle continue to show a favourable evolution. With the U-3 US unemployment rate at 3.7%, this means that, for now, the US Federal Reserve is likely to continue its 25bps rate hike per quarter. 

2.With the 10-year Italy-Germany spread at 327bps as we type (and BTPs volatility remaining high), investors are still looking for signs that the Italian government or the European Commission will be able to find a compromise. However, more relevant that politics are probably what "bond vigilantes" will continue to do over coming weeks. Higher Italy-Germany spreads (if sustained) could lead to a rise in Italy's average cost of debt, deterioration in financial conditions and therefore to downgrades by rating agencies. A substantial revision to its budget plans by the Italian government to bring them into line with the EU rules is still seen as unlikely, given that Lega and 5 Stelle remain focused on next year's European Parliament elections. Of special attention should continue to be the outlook assigned to Italy's sovereign debt issuer rating by S&P and Moody's if they decide to downgrade Italy (with the third-highest sovereign debt outstanding in the world) until the end of the month. 

3.As expected, in a letter addressed to Finance Minister Giovanni Tria, the EU considered that the country's DPB for 2019 constitutes "an obvious significant deviation" from EU rules, as the size of the deviation from the structural improvement recommended by the EU Council is "unprecedented in the history" of the Stability and Growth Pact. A response is required by 22 October. Tensions between the European Commission and the Italian government are likely to fuel new volatility spikes in Italian financial markets. 

4.The Portuguese government disclosed the Proposal of State Budget for 2019, which is expected to be voted in Parliament on 29/30 October. Regarding the macroeconomic scenario, the government sees real GDP growing by 2.2% next year (after 2.1% in 2018), well above consensus expectations (1.8%). The fiscal deficit is projected to reach 0.2% of GDP in 2019 (after 0.7% of GDP this year), while the primary balance is targeted at 3.1% of GDP in 2019 (vs. 2.7% of GDP in 2018). The structural balance is expected to improve by 0.3pp in 2019 to -0.3% of GDP. Italy and further declines in euro area equity indices remain risks to Portuguese sovereign debt. 

5.October's ECB meeting ends next Thursday. Investors are not expecting material news on policy or forward guidance. Focus should be on the reinvestment policy and the risk assessment, as well as on any comments regarding higher Italian bond yields. Business surveys suggest that the economy is still expanding at a healthy pace, although core HICP inflation remains at a low level.

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