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PATRIS Fixed Income Weekly - 21 September 2018

21 Sep 2018

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WEEKLY COMMENTARY

 1.The FOMC is widely expected to announce a 25bps hike in its FFR target range to 2.00%-2.25% when the September meeting ends next Wednesday. Monetary policy is now tougher, as the rate-hike cycle is well advanced, downside risks from foreign growth increased and the US economy has moved into its late stage. Focus should be on whether the June dot plot projection for a total of 4 hikes in 2018 and 3 hikes in 2019 is kept unchanged. The FOMC statement should continue to see current conditions as favourable, with solid household and business fixed investment, on the back of a strong labour market. We will also watch carefully if the FOMC decides to remove the "accommodative" language when characterising the stance of monetary policy. The August minutes suggested it is likely to change over the following meetings as many Fed officials believe it would no longer be appropriate. Fed officials may also update their views on balance sheet reduction. The key debate will probably be on whether to move monetary policy to restrictive next year.

 2.10-year UST yields are again trading above 3%, despite core CPI inflation printing well below consensus expectations in August. This has also pushed higher 10-year German Bund yields. US Federal Reserve Board governor Lael Brainard, usually considered a "dove", delivered a speech highlighting reasons that could support the tightening of monetary policy for some time, while suggesting that an inverted yield curve by itself would not be a reason to pause the rate hike cycle. Moreover, she expects the short-run neutral rate to exceed its long-term trend in the next year or two, which suggests that the FOMC may raise the FFR above its estimate of the long-term neutral rate. At the end of the day, all this discussion may not be all that important. The FOMC will probably continue to raise interest rates until there is evidence of a slow-down in economic growth. As we type, the Fed Funds Futures market already discounts four additional 25bps hikes by the end of 2019 (including the one expected for next week).

 3.BTP-bund spreads continued to tighten. A stronger move down will likely need clarity on the 2019 budget law. Budget uncertainty remains high, reflecting the differences amongst government members as suggested by press reports. Yesterday, 5 Stelle even threatened to exit the coalition. Rating decisions on Italy from S&P and Moody's are expected next month. The Economic and Financial Document should be released until 27 September.

 4.In a speech this week, ECB Executive Board member Benoît Coeuré supported the need in the future to give further guidance on the pace of stimulus withdrawal. However, he added that the ECB should not be expected to give a numerical forecast of the future path of short-term interest rates (i.e. a "dot plot").

5.In its monthly report for September, the Bundesbank said that it sees the pace of GDP growth accelerating in Germany, as the car manufacturing sector adjusts following the introduction of a new EU-wide car emissions testing system. Elsewhere, the Banque de France reduced its 2018 GDP growth forecast by 0.2pp to 1.6% and its 2019 growth forecast by 0.1pp to 1.6%. For 2020, the economy is also expected to expand by 1.6%.

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