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PATRIS Fixed Income Weekly Commentary - 02 November 2018

2 Nov 2018

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WEEKLY COMMENTARY

1.The FOMC is widely expected not to make any policy changes at next week's meeting, with the statement stressing the need to move towards further gradual increases in interest rates. Next week's FOMC meeting will be the last not including a press conference by the Chair, and will conclude on Thursday (and not on Wednesday) due to Congressional mid-term elections on Tuesday. Despite the stock market sell-off that took place in October, financial conditions have not tightened significantly, while the economy remains in a strong shape, with the unemployment rate at a 49-year low. Implied rates from Fed Funds Futures suggest that the FOMC will hike rates in December, with two more hikes priced for next year.

2.According to the Italian press, the European Commission is preparing to launch an Excessive Deficit Procedure against Italy this month, unless the government decides to revise its budgetary plans. The same source reports that the European Commission will support its decision on the breach of the debt rule (i.e. the need to reduce the debt-to-GDP ratio by 5% of the difference between the current level and 60%). At the end of the day, and even considering potential EDP fines, there is not much that the European Commission can do to force Italy to revise the 2019 budget.

3.According to preliminary data released by INE, real GDP expanded by 0.6%q/q in Spain in 3Q18, maintaining the pace recorded over the previous four quarters. The annual rate of growth was stable at 2.5%y/y. The Spanish economy remains resilient, in spite of weaker growth in the euro area, reflecting the strength in domestic demand.

4.ISTAT released this week that Italian GDP was flat q/q in 3Q18. Annualised growth was 0.1% q/q, the slowest pace since 4Q14. The press release mentioned that the economic slowdown was driven by a decline in industrial activity, while services output increased. Meanwhile, the contribution of domestic demand and net export were both null. Tighter financial conditions remain a risk to GDP growth over coming months. A weaker rate of GDP growth increases fiscal risks for 2019.

5.Softer economic data in the US and in the euro area, as well as the equity market decline, have pushed bonds yields lower. BTPs spreads in Italy have stabilised, following rating decisions by Moody's (BBB-/Stable) and Standard & Poor's (BBB/Negative). Investors will continue to follow the newsflow coming out of the European Commission. Additional signs of economic slowdown in Italy remains a key risk, giving that it would weaken debt sustainability dynamics. Next Thursday, the European Commission releases Autumn forecasts, including new data on Italy. 13 November is the deadline for the Italian Government to re-submit its 2019 budget to the European Commission.

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