Italy: Budget Buster

Italy: Budget Buster

Italy's newest budget defied European Union rules; Argentina and the IMF made yet another deal; the Fed hiked rates while the U.S. economy continued to grow

“I won't quit, for the good of the country…. we would throw the country into chaos."
Italy’s Finance Minister Giovanni Tria

Italy: Budget Buster At 11.1% of European Union (EU) GDP, Italy ranks fourth among the 28 member states. So it matters that its early budget, announced by leaders of the ruling coalition, has a deficit target of 2.4% – notably above the EU’s maximum threshold of 2%. As of the end of 2017 (latest figures available), Italy already had the largest public debt of any EU country, €2.5 trillion, according to EU agency Eurostat. The government is required to present a completed draft budget to the European Commission for approval by mid-October.

The budget, along with the defiant tone of its promoters, was a political slap in the face to moderate Finance Minister Giovanni Tria and a significant setback for financial markets. At the close of European trading on Friday, September 28, the FTSE MIB index of Italy’s stocks was down (3.72)%, the yield on Italy’s 30-year bond rose from 3.58% to as high as 3.78%, a hefty 20 bps. As of late in the day on September 28 Mr. Tria said he’d stay in office, “for the good of the country”.

Among the programs in the budget are a “citizen’s income” for the poor, tax cuts, and a rollback of pension reforms that had raised the retirement age.

Argentina: Strike up the band The International Monetary Fund (IMF) revised its deal with Argentina yet again, this time setting a band of currency values in which the peso would be permitted to “float” before the central bank could intervene.

The amount of aid for the overall deal is now a total of $57 billion, of which $15 billion has already been disbursed and $35 billion is disbursable between now and the end of 2019. The deal was described by IMF head Christine Lagarde as the “biggest ever”, covering almost all of the government’s $40 billion in foreign-denominated debt repayments due by the end of that year. But the funding is also available to be used to finance the budget if needed.

Important details of the new currency regime include that there would be “a floating exchange rate regime without intervention”, but with some allowances for “limited intervention to prevent disorderly market conditions” if there is “extreme overshooting of the exchange rate”. The band for the peso was set at 34 to 44 pesos per U.S. dollar. Outside of that range, the central bank would be able to spend up to $150 million per day from its reserves to support the currency.  The theory appears to be that covering Argentina’s foreign debt and budget would eliminate the prospect of a default and forestall, if not remove, the possibility of a severe austerity plan that would further harm people dependent on government programs such as pensions and salaries.

So far, the peso had traded as high as 41.54 per dollar, and closed trading on September 28 at 41.31.
 

U.S. Economy and the Fed: Upward and onward On Wednesday, the FOMC voted 9-0 to raise its target rate range 25 basis points (bps) to 2.25% - 2.00% (upper and lower bounds). Financial markets reacted calmly, as the hike was widely anticipated; after an intra-day wobble of just under 1%, the S&P 500 ended the day down (0.33%); the 10-year Treasury fell about 5 bps to 3.048%.

Observers saw the removal of the word “accommodative” from the Fed’s monthly Statement as the most newsworthy event. But Fed Chair Jay Powell took pains to say that the change didn’t reflect a shift away from its generally accommodative stance toward the economy. Given market reaction, it seemed that most readers accepted the explanation.

The week’s economic data was roughly in line with the Fed’s assessment.  Personal income was up 0.3% in August from July, as was personal spending. Core PCE inflation was flat for the month, keeping the year-on-year figure at the Fed’s preferred 2.0% level. There was, however, a notable pickup in wholesale inventories rising 0.8% for the month – a faster accumulation of wholesale goods than expected. Explanation vary, but one possibility is a slowdown in export shipping due to the effects of the rising tariff regimes put in place earlier in the year.

All data Source: Bloomberg, September 28, 2018, unless otherwise specified.

Definitions:

The Federal Open Market Committee (FOMC) is a policy-making body of the Federal Reserve System (Fed) responsible for the formulation of a policy designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

The Federal Funds rate (Fed Funds rate, Fed Funds target rate or intended Federal Funds rate) is a target interest rate that is set by the FOMC for implementing U.S. monetary policies. It is the interest rate that banks with excess reserves at a U.S. Federal Reserve district bank charge other banks that need overnight loans.

 

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