ref :- "Italian Bond Revival begins as S&P Holds Fire on Rating Cut" , Bloomberg Markets
When the going gets tough, you'll take whatever good news you can find ..... and without doubt the rating agencies have delivered some good news to Italy. A little more than a week ago Moody's retained their investment-grade appraisal of Italy's sovereign debt. Not by much, mind .... but maintaining that rating and avoiding a potentially disastrous move into "junk" territory was crucial. Late on Friday S&P Global Ratings downgraded its outlook on Italy to "Negative", but kept the rating at two levels above junk. Cue : a bounce in Italian bonds (BTPs), and a fall in yields, of course.
Societe Generale are quoted as believing that with these two investment-grade ratings safely secured, the yields on Italian debt are high enough to compensate for the risks attached to holding Italian paper, at least until the year-end. The Germany / Italy 10yr yield spread -- in other words, the amount of extra return that investors need for buying Italy's debt over Germany's -- has recently been as wide as 341 basis points, or 3.41%. It's trading below 300 bp as we write.
It would be hard to overstate the importance of hanging on to the investment-grade label for Italy. To lose it would mean that its bonds would fall out of global benchmarks that investors follow, and most crucially it would mean that they could no longer be included in the European Central Bank's asset-buying programme (QE). Now, as things stand the ECB is winding down QE and is due to terminate fresh purchases after December (even if some people have questioned whether the recent slowing in the Eurozone economy may prompt a rethink). Assuming for now the ECB goes ahead with its stated plans and ceases new bond-buying at the end of the year, there's still the question of replacing the debt it already owns as it matures. The ECB has no precise schedule for reducing its balance sheet, so for the time being it will be re-investing the proceeds of maturing bonds even if it's not making new purchases. But if Italy's debt was downgraded to junk status, we would have a situation where theoretically the ECB would not be allowed to replace maturing Italian bonds. As we say, maintaining investment-grade status is pretty fundamental to Italy's fortunes.
So it's a sunny Monday morning for BTPs but despite the relief, the basic issue of Italy's proposed budget deficit(s) hasn't gone anywhere. There's now less than three weeks before the government is supposed to re-present a budget that the ECB doesn't believe will increase Italy's mountainous debt. It's just possible that avoiding the heavy sanctions that Moody's and S&P could have delivered will embolden Italy's combative coalition leaders, Luigi Di Maio and particularly Matteo Salvini, in their fight to be allowed to flout EU fiscal rules. If that's the case, the relief factor might be short-lived. One thing you have to remember when talking about Italy's sovereign debt is that a very high percentage is held by Italian banks, and the last thing that Italy's teetering banking system needs is bond market losses and ever-widening spreads.
ref :- "Shares shock - Market turmoil poses risk to US economy as financial conditions tighten" , The Financial Times, Companies and Markets
Amidst all the gloom brought on by the stock market "correction" you could be forgiven for missing Friday's Q3 GDP figure , or at least for assuming that it must have been a bit of a disappointment. Hardly ..... it came in at an annualised +3.5%, above expectations of +3.3%. It seems very odd to read the headlines about the economy "slowing down" when it's still posting such impressive numbers, although technically it's correct -- Q2 saw growth of 4.2%.
It's not hard to predict what President Trump will make of it all : his policies have brought on a soaring stock market and a booming economy, and the "crazy" Federal Reserve -- with their repeated and unnecessary rate hikes -- have undermined the former and are in danger of doing the same to the latter.
The upward path of US rates has certainly played a role in the 8% fall in the S&P index in October, which if it remains at these levels will represent the worst monthly performance in nearly 10 years. But there are other factors that arguably have more to do with the fall in equity prices : Mr Trump's trade war and what it might do to future earnings have overshadowed the current earnings season, which itself has been a bit mixed and included some disappointing numbers in the all-important tech sector ; the realisation that the huge shot of adrenalin that was injected into the economy by Mr Trump's tax cuts will not last forever; and the strong dollar, a function of higher US rates for sure but then the Fed and others would argue that the level of rates is itself a function of the strength of the economy -- the implication being that the President can't take credit for one and blame someone else for the other.
Mr Trump's contention is that since there's no evidence of inflation pushing strongly through the Fed's 2% target, there's been no need for all of the 8 hikes so far (with more in the pipeline). The Fed of course has to be "ahead of the game" in controlling inflation but .... and whisper it quietly .... there's a chance, just a chance, that Mr Trump may get his way when it comes to December's expected rate hike.
The Fed's preferred measure of inflation, the Core Personal Consumption Expenditure Index, came in at just 1.6% for the third quarter -- below estimates of 1.8% and hardly evidence of galloping inflation pressures.
Looking more widely and beyond interest rates on their own, "Financial Conditions" are tightening sharply. Financial Conditions take into account a broader range of factors such as corporate borrowing rates, currency values, and share prices (which of course have been key of late as lower prices mean tighter conditions) alongside longer-term rates. The suggestion is that with financial conditions the way they are, the Fed's long-held intention to hike again in December is no longer the sure thing it once was. The probability of such an event , which has been above 80% as calculated by prices on futures markets, is now about 69%. Still odds-on, of course ..... but the argument against a move is certainly stronger.
Mr Trump may want to consider keeping quiet for a while when it comes to Fed policy (some chance !). If .... and it's a very big "if" indeed .... the Fed should want to change its mind, it's much less likely to do so if it gives the impression that the President has influenced their decision.