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U.S. Economy: "Historically Rare"

Fed Chairman Powell reiterated the FOMC’s view of the economy as unusually favorable; Argentina has made some gains, courtesy of the IMF; Italy’s latest budget is still a work in progress.

U.S. Economy: “Historically Rare”

In the days since last week’s target rate hike, Federal Reserve Chairman Powell has been adding color to the FOMC’s views on the economy, most notably at Monday’s National Association of Business Economics conference. He described the current state as “historically rare”, “[a] pairing of steady, low inflation and very low unemployment”, but noted the central bank was nevertheless watching carefully for signs of unexpectedly strong inflation. The generally optimistic tone of his remarks suggested to many observers that gradual rate hikes would continue for now.

Market expectations are for another 25 basis-point rise at the conclusion of the FOMC’s December 18-19 meeting, with public debate focusing on whether future hikes would go beyond the ill-defined and elusive “neutral rate”; whether the recently-concluded United States-Mexico-Canada Agreement (USMCA), whose scope was less broad than many expected, might provide a template for other trade deals, with relatively small adjustments to existing arrangements; and how the conclusion of that agreement might impact future trade policy with respect to China.

On the Rise: Argentine Peso

The Argentine economic crisis is following a new script, in which the International Monetary Fund (IMF) is focused on the potential damage of any austerity program as well as the felt need to restore the confidence of creditors, both current and future. Judging from markets’ reactions over the past few days, the script’s intended audience appears engaged.

The new approach has been born of necessity. When Argentine President Macri asked the IMF to deliver its aid faster than originally planned on August 29, markets reeled; the Argentine peso plummeted from about 31.4 to as low as 41.2 to the dollar before trading in the 37-40 range for the following few days. And when Macri met with IMF Managing Director Christine Lagarde during the recent United Nations (UN) General Assembly meetings last week, his announcement of an unspecified impending deal provoked a similar reaction. But when the details of the new arrangement were made – including the IMF’s endorsement – the peso traded upward, ending trading on October 2 at 38.07 per dollar.

Details of the new arrangement include the availability of enough credit and funds from the IMF to fully fund Argentina’s operating budget, as well as all of its payments due on dollar- and euro-denominated debt, as well as assurance that Argentina’s central bank would allow the peso to float, without intervention, within a “band” between 34 and 44 pesos per dollar.

On the Slide: Italy’s Budget Discipline

Italy’s coalition government produced its draft budget on time for the European Union’s (EU) review and approval this coming week. But at 2.4% of GDP, the budget’s proposed deficit is well above the EU’s 2% limit. The deficit was a disappointment but not a surprise, given the government’s proposed expansive social welfare programs, including a guaranteed “citizen’s income” as well as a rollback of recently-implemented increase in the minimum age of retirement.

The defiant tone of Italy’s political rhetoric suggests that any upcoming negotiations could be both noisy and protracted. But Italy’s bond market reaction was immediate; 5-year government bond yield jumped from 1.709% on September 18th to as high as 2.76% on October 2.

Legg Mason , October 8

P.S.

All data Source: Bloomberg, October 2, 2018, unless otherwise specified.

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