The developed countries’ central banks are moving towards less accommodative monetary policies, albeit at different speeds (see Figure 16). The major central banks’ cumulative net asset purchases will soon turn negative, and for the first time since 2008, USD investors will be able to take no risk and beat inflation because the real yields on short-term US Treasury debt are now positive.
While maintaining a certain amount of flexibility, the Fed’s path has been set. During his Jackson Hole speech, Fed Chairman Jerome Powell stressed the benefits of its current steady approach. Rate rises will be prudent but, according to the Chairman, if inflation expectations shift, then the Fed will act decisively. The Fed’s current median rates estimates are for three quarter-point rises in 2019, although four such rises are not out of the question. Fed funds rate futures are only fully pricing in two rate rises (see Figure 17).
ECB policy normalisation should also entail a gradual rise in eurozone rates. In line with comments from ECB chief Mario Draghi indicating that there will be no rate rises before summer 2019, the markets are pricing the first rate increase for the very end of next year (see Figure 18). The expected pace of rate rises continues to be very gradual.
Uncertainties surrounding Italy have only slightly affected periphery-country and financial spreads (see Figure 19) indicating that investors are currently ring-fencing this specific risk.
Financial debt spreads widened after Italy’s 4 March 2018 elections but remained stable during a second wave of tensions in July concerning the country’s debt levels.
In terms of credit, high yield European spreads have widened slightly, but the fundamentals remain healthy (see Figure 20).
If the Italy risk dissipates, strong long-term European fundamentals should see the euro appreciate against the dollar, along with additional support from a stabilised interest rate differential between Europe and the US.
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