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The Fed’s statement following the June meeting shook the markets into a new place. Bernanke indicated that if the growth and employment trends continue as expected, the FOMC may start to reduce the pace of asset purchases “later this year” and, if conditions remain favourable, the reduction will continue “in measured steps”» in 2014, ending after the unemployment rate hits 7%, probably “around midyear”. Consensus ahead of the meeting expected the pace of asset purchases to start moderating in October (our forecast: August-September), therefore not far off Bernanke’s indications. A more important element in guiding market movements was the information provided on rate expectations, which marks the start of the future restrictive cycle. The reversal is still “far in the future”, with 14 participants (out of 19) expecting the first hike by the end of 2015 (13 in March). However, the distribution of the level of rates sends a more hawkish message than was the case in March: 13 participants expect a policy rate of at least 1% by the end of 2015, compared to 9 in March; 7 expect rates at 1.5% or above (vs. 3 in March).
A part of this shift, justified by the improvement in the economic outlook, has transferred to fed funds futures, which for June 2015 have risen to 0.7% from 0.475% on 18 June. Therefore, the market’s position is close to that of the “median FOMC participant”: forthcoming economic data will be decisive in guiding the next movements. A real rollercoaster ride lies ahead next week: our forecasts are for a rise of the ISM to 51.5, as opposed to a slightly slower rise in nonfarm payrolls, which should slow in June (temporarily) compared to May (see “This Week’s Market Movers”). Volatility is guaranteed.
Interesting developments, albeit mixed, also came from the European front. First of all, Chancellor Merkel promised her party to make Germany the engine of European growth, making the most of the margin allowed for fiscal policy. On paper, this is an interesting development, which goes in the direction of a symmetry of fiscal policies, which at the moment represents the only real achievable surrogate of a fiscal union. In practical terms, however, it remains to be seen if and when this will translate into tangible measures to support demand.
Second, the IEB and the European Commission should present a number of options at the European Council of 27 and 28 June to kick-start lending to small and medium enterprises in Southern Europe. Rumours on the contents of the proposals have been reported by press agencies this week, and tell of 55-100 billion euros in loans which could be activated by the programme over an undefined time horizon as yet: 1-2% of the stock of loans to non-financial firms in the euro area, too little to independently and effectively support the recovery. Third, the extension of the deadlines for achievement of fiscal targets by France, Spain, Holland, Slovenia, and Portugal, went smoothly, as did Italy’s exit from the excessive deficit procedure: orientation towards a slightly more flexible approach to the application of the Stability Pact seems to be confirmed, although, adjusted by the cycle, implementation of the recommendations will imply
some fiscal consolidation in 2014 as well. Fourth, on Wednesday the Ecofin was expected to reach an agreement on the second pillar of the banking union, the single resolution mechanism, after the failure of Friday’s attempt. The structure taking shape provides for the ESM to play a role in direct capitalisation, albeit with strong limitations: (i) the credit ceiling amounts to only 60 billion euros in total; (ii) an adequate bail-in must be applied; (iii) the financial costs will be shared with the Member State “to ensure that incentives remain aligned”; (iv) the bank must be subject to single supervision; (v) retroactive application will be decided case by case, unanimously. Intervention of the ESM remains a last resort, after the participation of shareholders, creditors, and of the national fund, but also after (or jointly with) the intervention of the Member State. Given these limitations, the aim of severing the ties between banks and sovereign issuers will only be achieved in part. What’s more, progress towards achievement of the third pillar, i.e. a common system of deposit protection, is not expected to go much beyond a harmonisation of national regimes. Ultimately, significant progress has been made only towards the first pillar, i.e. the single supervisory mechanism.
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Important Disclosures
This research has been prepared by Intesa Sanpaolo S.p.A. and distributed by Banca IMI S.p.A. Milan, Banca IMI SpA-London Branch (a member of the London Stock Exchange) and Banca IMI Securities Corp (a member of the NYSE and NASD). Intesa Sanpaolo S.p.A. accepts full responsibility for the contents of this report. Please also note that Intesa Sanpaolo S.p.A. reserves the right to issue this document to its own clients. Banca IMI S.p.A. and Intesa Sanpaolo S.p.A. are both part of the Gruppo Intesa Sanpaolo. Intesa Sanpaolo S.p.A. and Banca IMI S.p.A. are both authorised by the Banca d’Italia, are both regulated by the Financial Services Authority in the conduct of designated investment business in the UK and by the SEC for the conduct of US business.
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Valuation Methodology
Trading Ideas are based on the market’s expectations, investors’ positioning and technical, quantitative or qualitative aspects. They take into account the key macro and market events and to what extent they have already been discounted in yields and/or market spreads. They are also based on events which are expected to affect the market trend in terms of yields and/or spreads in the short-medium term. The Trading Ideas may refer to both cash and derivative instruments and indicate a precise target or yield range or a yield spread between different market curves or different maturities on the same curve. The relative valuations may be in terms of yield, asset swap spreads or benchmark spreads.
Coverage Policy And Frequency Of Research Reports
Intesa Sanpaolo S.p.A. trading ideas are made in both a very short time horizon (the current day or subsequent days) or in a horizon ranging from one week to three months, in conjunction with any exceptional event that affects the issuer’s operations. In the case of a short note, we advise investors to refer to the most recent report published by Intesa Sanpaolo S.p.A’s Research Department for a full analysis of valuation methodology, earnings assumptions and risks. Research is available on IMI’s web site (www.bancaimi.com) or by contacting your sales representative.
Source: BONDWorld – Intesa Sanpaolo – Research Department
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