Global Economy & Markets, Weekly Roundup 25/09/18

25/09/2018 - Reports

Global Economy and Markets

The Fed is expected to increase interest rates to 2.25%, with US monetary policy coming out of accommodative territory for the first time in 10 years 

Key Takeaways

Investor attention in the week ahead will turn to: i) the US Federal Reserve bank meeting on Wednesday 26th; and ii) the Italian 2019 Budget proposal on Thursday 27th.

The Fed is expected to raise the federal funds rate target by 25 bps, to 2.0% - 2.25%. Investor focus will be on the FOMC participants’ estimates (“dots”) for the path of the federal funds rate. Currently, FOMC projections for future rate increases indicate 2 additional hikes by end 2018 to 2.50%, 3 hikes by end 2019 to 3.25% and 1 hike for end-2020 (3.50%). We see little room for the 2019 forecast to increase by 1 hike.

The Fed will likely gradually move to a restrictive policy (unless there is a significant deterioration in global growth) on the back of: i) above-trend growth, with US real GDP at 2.7% in H1:2018 due to fiscal support; ii) increasing inflation, with PCE and core PCE at 2.3% and 2.0% yoy, respectively; and iii) the unemployment rate is at a multi-year low of 3.9% (and significantly below its natural rate of 4.6% according to the CBO).

The Italian 2019 Budget is of significant importance, particularly for EUR-based investors. According to the previous Draft Budgetary Plan (DPB), the headline budget deficit was expected at -0.9% in 2019 and -0.2% in 2020. The Lega/M5S coalition agreement initially included significant fiscal expansion compared with the 2018 DPB, but we expect both parties to reduce their fiscal ambitions in order to not put at risk the goal of reducing the public debt (131% of GDP) and subsequently raise tensions with the EC.

The 2019 government budget deficit target, according to sources, could be set at -1.5-2% of GDP in the updated Economic and Financial Document (DEF) on Thursday. Anything below -2% may likely cause a negative market reaction in view of the high negative correlation of BTP Government bond spreads with Italian bank equities (see graph page 3). Note, however, that the Italian Budget proposal to the EC is due on October 15th, while negotiations could last until end November.

Global equity markets rose across the board, as the escalation in trade tensions between the US and China was less intense than feared. Indeed: i) the US set the tariff rate to be imposed (on $200bn worth of Chinese imports) at 10%, at least initially (instead of 25%); and ii) China responded mildly (5% to 10% tariff on $60bn worth of imports from the US) and reiterated its intention to cut average tariff rates on imports from most of its trading partners, supporting investors’ risk appetite in the past week.

Overall, the MSCI World index was up by 1.6% wow (+4.3% ytd), with emerging markets (+2.2% wow | -9.2% ytd) overperforming their developed market peers (+1.5% wow | +4.6% ytd). The Autos sector (which is highly sensitive to global trade conditions MSCI) overperformed (+3.8% wow | -11.0% ytd), as did Financials (+3.1% wow | -3.8% ytd) due to higher bond yields.

On the other hand, China cancelled trade talks with the US over the weekend. We believe that it is unlikely that the trade tensions between the US and China will be resolved before the November US Congressional Elections.