Global Daily – Fed to express inflation concern?

by: Nick Kounis , Kim Liu

Fed Preview: Inflation language the main event – The FOMC will announce the outcome of its meeting tomorrow. We do not expect a change in policy rates, but the language in the statement will be closely watched. In particular, the FOMC’s evolving views on inflation will give markets direction. We think that the committee will stick to its base case that inflation ‘is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee’s 2 percent objective over the medium term’. This seems based on the view that the labour market is tight and there will be ‘some further strengthening in labor market conditions’. However, we expect the FOMC to recognise the risks surrounding this view. Indeed, Chair Janet Yellen already alluded to this in her recent testimony to Congress (12 July), where she expressed ‘uncertainty about when–and how much–inflation will respond to tightening resource utilization’. In its previous statement (14 June), the FOMC had noted that it was ‘monitoring inflation developments closely’ and in tomorrow’s edition, it could step up its dovish language on inflation. We expect the Fed to delay its next rate hike until December, with risks skewed towards a longer pause. For next year, we expect two rate hikes. (Nick Kounis)

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Euro Macro: Business surveys support ECB’s path to slow QE exit – Various surveys of business activity in the eurozone suggest that the economy continues to grow at well-above-trend rates. Germany’s IFO business climate indicator rose to 116 in July (consensus: 114.9) from 115.2 in June, taking it to its highest level since 1991. Crucially, the expectations sub-component – which is a more accurate barometer of GDP growth than the overall index – also rose. The flash PMI surveys for the eurozone for this month (published yesterday) were not quite as buoyant. The composite slipped to 55.8 from 56.3 in June. However, it is still at levels consistent with strong growth. The latest business surveys should further increase the ECB’s confidence in the outlook for growth. Although inflation is currently subdued, the central bank judges that with this kind of economic momentum, inflation will gradually move towards its goal over the medium term. We expect the ECB to start tapering its asset purchases from the beginning of 2018. (Nick Kounis)

Euro government bonds: Successful Greek bond market return – Preliminary reports show that the Greek government was able to raise EUR 3bn from its new five-year benchmark bond at yield of 4.625%. The issued amount was evenly split between investors who decided to sell their two-year remaining Greek sovereign bond holdings back to the Greek government at a premium and to buy the new five-year transaction and new investors. Overall demand was strong, with the combined book size exceeding EUR 6.5bn. The transaction details, in particular the proportion of new investors, should give the Greek government renewed optimism about it being able to attract more external funding in the future. In addition, by buying back EUR 1.5bn of bonds which would redeem in 2019, the Greek government has smoothed out its redemption profile. This will lower the refinancing need in 2019 and lowers the challenge for the Greek government when the current bailout programme ends in August 2018. Furthermore, the yield at which the five-year bond deal was printed was at the lower end of market expectations. Indeed, the initial guidance was lowered during the day from 4.875% to 4.625% as investor demand surpassed the envisaged issued amount. From a signalling perspective, this level is important as it is lower than the 4.95% issuance level when the Greek government sold a five-year sovereign bond for the last time in 2014. Although definitive pricing details are not yet published, today’s transactions were most likely carried out on a cash neutral basis. By doing so, the Greek government adheres to a technical debt ceiling which was imposed by the IMF. This ceiling limits the amount of Greek debt outstanding and prevents the Greek government from increasing its liabilities further. (Kim Liu)