Global Daily – Deconstructing the changing FOMC

by: Bill Diviney , Aline Schuiling , Shanawaz Bhimji

US Macro – Considerable uncertainty remains about the 2018 FOMC composition – It is a fairly packed schedule for Fed speakers this week, with voting members SF Fed President Williams and Atlanta Fed President Bostic delivering speeches yesterday (only the latter made remarks with implications for policy decisions), and NY Fed president Dudley due to speak Thursday. Among non-voters there are also speeches from Kashkari (today), Evans and Bullard (tomorrow), and Rosengren (Friday). Bostic firmly nailed his dovish colours to the mast in yesterday’s speech. He argued that the Fed was already approaching a neutral policy stance, and that him favouring a slow removal of accommodation ‘doesn’t necessarily mean as many as three or four moves per year’ (we expect two steps).  He was also sceptical of the growth impact of the Republican party’s tax bill, pointing to business survey evidence that suggested only 15% of respondents would raise capital spending by more than 10% in response to the measures.  Bostic is one of 5 FOMC members gaining voting rights this year, so his views will draw greater market attention than they have up until now. However, he is also one of the few doves to gain a vote this year. Of the other new voters, Mester, Williams, and the recently appointed Marvin Goodfriend are hawks, while the views of new Richmond Fed president Thomas Barkin – a former ex-McKinsey executive – remain unknown.  Of the total 12 voting members this year, there are still 3 board vacancies to be filled by President Trump, while NY Fed president Dudley is due to retire in mid-2018.  While incoming Fed Chair Powell is likely to retain a dovish tilt, the vacancies on the FOMC means there is still considerable uncertainty over the final balance of hawks and doves on the committee. (Bill Diviney)

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Euro Macro: Italy’s government debt to decline only temporarily – Italy’s government finances have improved significantly since the start of the economic recovery. The budget deficit declined from 2.9% in 2013 to 2.1% in 2017. This was due to the positive impact from the high level of economic growth and the drop in government bond yields, which mainly resulted from the ECB’s expansionary monetary policy. Although Italy’s GDP growth rate remained well below that of the eurozone, it has been above Italy’s own trend growth rate during the past few years. Meanwhile, the government’s interest payments dropped from 4.8% GDP in 2013 to 3.7% in 2017. The government’s debt ratio (which is amongst the highest in the eurozone) is expected to decline in the next few years. We expect it to fall from 132% GDP in 2017 to 129% in 2019. However, thereafter it will probably start rising again. Firstly because the underlying budget balance has actually deteriorated in the past few years. When the impact of the business cycle and the drop in bond yields are eliminated, the so-called structural primary budget balance dropped from +4% in 2013 to +1.7% in 2017. We do not expect this adjusted balance to improve noticeably in the coming years. The political landscape is fragmented and the upcoming general elections are unlikely to result in a stable coalition that is able to implement radical policy changes. Moreover, economic growth is expected to return to around the trend rate in the years after 2019, while interest rates should start moving higher as the ECB is expected to gradually end its QE programme after September 2018 and start hiking rates as from September 2019 onwards. Consequently, we expect Italy’s government debt to start moving higher again. For more details please read our note here. (Aline Schuiling)

Euro Credit – Steinhoff has limited implications for the ECB’s CSPP policy – The ECB decided to sell its bonds in troubled retailer Steinhoff, supposedly at a loss of EUR 50m. Steinhoff bonds were purchased by the ECB in the summer of 2017 as part of the CSPP program and at a time when the bonds were still rated investment grade. As a result of accounting irregularities and fears about company liquidity, Steinhoff senior bonds were downgraded (in two steps) to Caa1 by Moody’s. What are the implications of the sale for the ECB’s CSPP policy going forward? Well the action clearly shows that the ECB is unwilling to hold on to distressed assets. Surely an event like Steinhoff will have raised a few eyebrows in the Governing Council. However, we think the ECB will continue its overall CSPP purchases at the same level this year, despite the slowdown in the overall APP. During the December ECB press conference, President Mario Draghi admitted that its Steinhoff holdings would create a loss, but underlined strongly the success of the CSPP program in its primary goal of easing financing conditions. Secondly, during the same press conference Mr. Draghi highlighted that from a total portfolio perspective, the program remains a success, where the loss on Steinhoff represents only a minor fraction of the total interest gains made on the program (reportedly EUR 1.6 bn annual net interest income). Finally, when we look at the quality composition of CSPP, it already shows that the ECB is playing it rather safe .Compared to the broad non-financial market, the CSPP portfolio has an 8 point higher allocation to single A names, which is largely funded from being 6 points underweight in BBB’s. Therefore there is no real need to change style of purchases and we should not see diverging spread movements between non-financial A and BBB’s. (Shanawaz Bhimji)