The Markets
The Fed‘s dovish stance at its November meeting sparked a corrective rally in US Treasuries (and core bonds in general). A modestly positive US CPI print encouraged investors to add to pivot bets last Tuesday, circling the March 2024 policy meeting as the earliest starting point for a rate cut campaign. Last Friday’s intraday action – which failed to close the week above post-CPI highs as traders threw in the towel on better-than-expected but second-tier Housing Starts and Building Permits – suggests consolidation in this holiday-shortened trading week.
U.S. markets are closed on Thursday for Thanksgiving, and volume is traditionally light on (black) Friday as well. Daily changes in the US yield curve ranged from +4.8 bps (2yr) to -2.6 bps (30yr), with the German curve moving in parallel (+1.4 bps at the front end and -2.8 bps at the very long end). The (trade-weighted) dollar remains in dire straits even as the core bond rally seems to be losing some steam. The DXY extended its slide this morning, falling to 103.70, its lowest level since early September. Key support levels are 103.46 and 102.55, which are the 50% and 62% retracements, respectively, of the dollar’s rally from mid-July to early October.
EUR/USD is already above the 50% level (1.0862), with the 62% level (1.0960) nearby. Positive EU rating action (see News & Views), bullish risk sentiment in equity markets (China & South Korea doing well this morning) and still some underlying USD weakness could force a test later on. However, in line with our consolidation view for core bonds, the 1.0960 level could be a tough nut to crack. Today’s eco calendar is extremely thin.
We have our eye on the $16bn 20-year US Treasury auction this evening. During this month’s mid-month refinancing operation, the 30-year auction showed signs of weakness and also triggered an intraday market move (lower US Treasuries). Speeches by some ECB members and BoE Governor Bailey (after the European close) are wildcards for trading. Bailey’s speech comes as the Pound is drifting slightly lower and is about to jump back into the broad EUR/GBP 0.8750-0.90 range after a long stay in the 0.85-0.8750 area.
News and Views
Moody’s has affirmed Italy’s Baa3 rating and raised its outlook from negative to stable. The change reflects a stabilization of the outlook for the country’s economic strength, supported by the implementation of the post-pandemic recovery plan (NRRP), the health of the banking sector and government debt dynamics. Growth over the next few years reduces the risk of a material and rapid deterioration in the fiscal position. Nevertheless, fiscal strength remains constrained, with the debt-to-GDP ratio expected to remain high at 140% in the coming years.
And this is highly sensitive to assumptions about growth, interest rates and the budget balance. Even a small deviation from the baseline could put the debt burden on a more pronounced upward path. The debt has an average maturity of about 7 years, but its affordability will weaken relatively quickly due to high annual borrowing needs. Moody’s takes into account the ECB’s TPI, which limits the sovereign’s exposure to liquidity stress.
The lowest possible investment grade is supported by the country’s large, diversified and competitive manufacturing sector, high household wealth and low private sector debt. However, institutional weaknesses are likely to prevent the country from fully benefiting (through higher potential growth) from the so-called once-in-a-generation NRRP opportunity.
Moody’s raised Portugal’s rating by two notches from Baa2 to A3 with a stable outlook. The decision “reflects the sustained positive medium-term credit implications of a series of economic and fiscal reforms, private sector deleveraging, and continued strengthening of the banking sector.”
Over the next few years, and in contrast to other aging countries, Moody’s expects the negative impact of demographic trends on potential growth to be mitigated by sustained net migration, higher labor force participation rates, and an increase in labor productivity growth. Solid growth and broadly balanced budgets mean that the debt burden, although elevated, will continue to decline (to +/- 100% in 2024, the lowest level since 2010) at one of the fastest rates among advanced economies.
More positive trends in economic and fiscal strength than currently expected are balanced by recent evidence of political risks. The agency cites the recent resignation of the prime minister over a corruption investigation.
