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PATRIS Fixed Income Weekly - 28 September 2018

28 Sep 2018

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WEEKLY COMMENTARY

1.The Federal Reserve increased its interest rates by 0.25% on Wednesday, raising the fed funds target range to 2.00%-2.25%. In his post-meeting press conference, Chairman Jerome Powell showed optimism about US growth and downplayed the trade tension with China. The Summary of Economic Projections median estimate for this year was increased to 3.1% from 2.8% in June, while 2019 GDP growth is now seen at 2.5% (up by 0.1pp from June). Despite this favourable economic backdrop, FOMC September Fed fund projections didn't show meaningful changes from the June meeting. The 2019 median dot still pointed to three additional 25bps rate hikes, and one in 2020. The median longer-run dot, reflecting the FOMC view of the nominal neutral rate, was slightly upgraded to 3.0%, despite the fact that the long-run potential growth estimate for the US economy was kept unchanged at 1.8%. Chairman Jerome Powell reaffirmed the idea that future monetary policy decisions remain data dependent. Nevertheless, the September dot plot showed 12 out of 16 Fed officials converging towards one additional 25bps rate hike this year. The Federal Reserve will let $30bn of Treasuries and $20bn of mortgages debt securities mature per month starting in October. At the end of the day, the FOMC is still likely to maintain its 25bps rate hike pace until there is a deterioration in the outlook for the US economy. As we type, 10-year UST yields remain above 3%. Moreover, FOMC's current debate around the neutral rate, as suggested by the recent speech by Federal Reserve Board governor Lael Brainard (short-run neutral rate could exceed its long-term trend in the next year or two) may in the near-term support some steepening of the curve.

2.In Italy, the government seems to have agreed on a 2019 budget deficit of 2.4% of GDP. This will probably reduce the credibility of Finance Minister Giovanni Tria, as well as face resistance from the EU and rating agencies.

3.The European Commission's measure of economic sentiment in the euro area continued its decline in September after peaking in December 2017. The ESI remains elevated in historical terms, above the long-term mean and consistent with GDP growth above potential. Domestically-oriented sectors showed a more favourable dynamic than manufacturing, while construction sentiment reached a new all-time high. Elsewhere, according to data released by the ECB, private sector loans growth adjusted for sales and securitisations accelerated from 3.3%y/y in July to 3.4%y/y in August, still below nominal GDP growth. Within that, non-financial firms' loans growth stood at 4.2%y/y in August (vs. 4.0%y/y in July).

4.France's draft budgetary law for 2019 forecasts the public deficit to widen to 2.8% of GDP in 2019, following 2.6% in 2018 and 2.7% in 2017. In terms of structural adjustment, the government estimates that it will be worth 0.3pp of potential GDP in 2019 after 0.1pp in 2018. The public debt-to-GDP ratio is expected to stand at around 98.6% of GDP in 2019, after 98.7% in 2018 and 98.5% in 2017. The key underlying assumptions for 2019 are real GDP growth of 1.7% and headline inflation of 1.4% (1.1% for core).

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