Market Update: Fed forecasts further monetary tightening as Italian coalition outlines budget

Market Update: Fed forecasts further monetary tightening as Italian coalition outlines budget

2nd October 2018

LAST WEEK – KEY TAkeAways

United States: Fed forecasts upward trajectory for interest rates

  • US equities rallied, but the US dollar stayed flat, as the Federal Reserve raised interest rates to a target range of 2% to 2.25%;
  • The latest hike was the eighth in the current cycle, and the third in 2018, and the Fed hinted that it would increase rates once more this year and three times in 2019;  
  • Fed Chair Jay Powell hailed the strength of the American economy and acknowledged concerns about trade tariffs, but he argued they did not appear to be making an impact yet;
  • Omnis view: While this hike- and arguably the next one- are already priced into the markets, the most useful take away from the Fed’s latest meeting could be the forward guidance it provided for the monetary tightening cycle in 2019. We will be watching corporate bonds as the tightening cycle in the US progresses. If the economy slows then stress may become evident for companies at the lower end of investment grade.

Europe: Euro weakens following Italian budget u-turn

  • The euro rose against the US dollar and EU sovereign bond yields climbed at the start of the week, as European Central Bank President Mario Draghi said higher wage growth resulting from a tightening labour market should spur inflation;
  • The euro handed back some of those gains, and Italian bond yields jumped, as the country’s populist coalition government unexpectedly announced it plans to increase fiscal spending in its upcoming budget, although it will not breach EU rules on its budget deficit;
  • The euro weakened further against the US dollar following Friday’s release of eurozone core inflation data which fell short of forecasts;
  • Omnis view: The Italian coalition government caught the markets by surprise after hinting at a more prudent fiscal policy in the run-up to its budget announcement. This u-turn might lead to tension between Italy and the EU and impact sentiment towards the region. However, a weaker euro could boost exports which is one of the main drivers of EU economic growth.

United Kingdom: Relative calm as Brexit deadline approaches 

  • It was a relatively quiet week by Brexit standards, which helped sterling recover ground against the US dollar following the turbulence triggered by the Salzburg summit;
  • Omnis view: Our base case remains that a soft Brexit is most likely, possibly followed by a harder Brexit at a later stage. However, once the November deadline passes we should have greater clarity about the outcome, which to a certain degree markets will welcome regardless of what kind of deal is agreed.

Emerging markets: Argentina secures IMF loan

  • The peso fell against the US dollar as Luis Caputo, Argentina’s central bank President who advocated intervention in the currency markets, resigned after only three months in the job;
  • The peso then rebounded as Caputo’s resignation allowed talks to progress about accelerating the distribution of a $50 billion loan from the International Monetary Fund (IMF) which prefers free-floating currencies;
  • Ultimately, the IMF increased the loan to $57 billion and agreed to let Argentina receive a bigger share of the money before the end of 2019;
  • Omnis view: While Argentina’s economic woes are contained, these positive developments should boost sentiment to emerging markets (EMs) as a whole and support the sector’s fledgling oversold rally.

Commodities: Oil price rally could boost UK and EM equities

  • Oil hit a multi-year high of $82 per barrel following a meeting of the Organization of the Petroleum Exporting Countries (OPEC) at the end of the previous week;
  • OPEC members decided against raising production at the meeting, despite an appeal by US President Donald Trump to dampen the price by increasing output;
  • Omnis view: Rising oil prices could be good news for the energy-heavy FTSE 100 and may also support the recent rally in EM.

Looking Ahead - Talking Points

Economic data: US to release monthly labour market data

  • The non-farm payroll (NFP) report is released on Friday, with the consensus view that the number of jobs added to the US economy in September will fall slightly from the previous month;
  • Omnis view: The Fed closely monitors the labour markets when deciding about interest rates, but a small drop in the monthly NFP report is unlikely to change its current trajectory.

Companies: Third quarter corporate earnings season starts 

  • Pepsi, Tesco and Costco are among the big names announcing third-quarter results this week;
  • Omnis view: Financial analytics firm Factset is forecasting a slowdown in the estimated earnings growth rate to 19.3% in the third quarter from around 25% in the previous quarter, which may serve as a headwind for global equity markets.

US corporates will have to deliver solid earnings to justify the growing valuation premium

Bulletin - 021018

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