Markets
The Fed kept the policy rate unchanged at 3.75%-4% yesterday. Two members, Governor Cook and the board’s most hawkish Cleveland Fed Hammack, voted for an immediate hike. The statement saw some twists: economic activity was upgraded from expanding at a “solid” pace to a “strong” one. Inflation remains elevated and the language shifted from a “timelier” return to a “timely” return to 2%. “The accumulation of more information will help the Committee determine the policy stance appropriate to ensure” just that. This newest addition to the statement covers for the upcoming data batch and sets the stage for a December move. US GDP growth and PCE deflators, if anything, will underscore the strength of the economy and rising price pressures that go with it. The bar for Q3 growth is set at 3.2% and for September (core PCE) at 3.6% (3.1%). We consider the risks for both tilted to the upside. Chair Warsh during the presser was bullish as usual: economic growth is strengthening, capex is high and broadening in sectors outside tech, consumer spending is healthy, the jobless rate is lower and unemployment insurance claims continue to run at the lowest level in generations. The focus remains on inflation. Warsh said financial conditions have tightened but is unwilling and unable to call them tight. This marks a shift from calling them outright “accommodative” back in September. It is one of the key reasons why the Fed yesterday didn’t increase rates just yet. The other being market-based inflation expectations having declined since the September meeting. That’s debatable and subject to the gauge used. Anyway, the US curve steepened with daily changes varying between -4 bps (2-yr) and +3.3 bps (30-yr). The dollar fell a touch against the euro after testing the 1.1113 multiyear high mere hours before. EUR/USD finished around 1.1154 but is returning most of those “gains” again in cautious trading this morning.
From the Fed we move to the ECB. Frankfurt is widely expected to keep rates steady at 2.5%. As with the Fed yesterday, asking what the central bank held back in hiking today is legitimate. The economy shows resilience and inflation is rising, this month probably to 4%+ levels. Energy prices have moved significantly beyond the central bank’s adverse assumptions. Dutch natural gas prices for example exceeded €100/MWh yesterday. Brent oil stabilize near $114-115/b. Both headline and core inflation in that scenario are expected to remain (well) above the 2% target through the entire policy horizon (2028). Long-term rates have eased around 15 bps since the September meeting and more than double that since president Lagarde’s appearance before the European Parliament. She referred back then to the tightening impact of the increase in the run-up. Tuesday’s Bank Lending Survey showed that it does filter through but relying on the market alone to keep inflation in check as a policy strategy is risky. We expect the ECB to lean hawkish and set the stage for a December hike without committing to anything in specific. The French situation will surely be a topic in the Q&A. The ECB usually refrains from commenting individual member states and in any case has an easy way out with the TPI mechanism.
News and views
The Italian government yesterday agreed its draft 2027 budget. It will now have to pass its way through parliament. Like the UK budget yesterday, it focuses on short-term support measures to ease the cost-of-living crisis while largely keeping the longer term fiscal framework in place. Family policy and business competitiveness are two other pillars in the Meloni-government’s policy. The budget assumes real GDP growth of 0.8% in 2027, 0.9% in 2028 and 0.8% in 2029, with public debt rising slightly from 138.1% of GDP in 2026 to a peak of 138.5% in 2027 before declining to 136.6% by 2029. The headline deficit is projected at 3.4% of GDP in 2027 and 3.2% in 2028 before falling to 2.3% in 2029, but these figures include use of the EU’s new National Escape Clause; excluding that flexibility, the deficit would be 2.8%, 2.6% and 2.3% respectively. Defense, energy security and related strategic expenditure are treated separately from the normal adjustment path agreed with the European Commission. This allows Italy to temporarily remain above the Maastricht 3% deficit threshold while still claiming compliance with the EU expenditure rule and maintaining a rising primary surplus trajectory. Targeted levies on specific sectors are the other main way to get revenue. Politically, these projections stretch beyond the expected next Italian general election, which is due by autumn 2027.
