Power to the people: What Italy’s referendum means for markets

Italy will hold a much-anticipated referendum on constitutional change on the 4 December. While the passing of the referendum would bring greater electoral stability in the future, there is an increasing risk that the referendum will result in a ‘No’ vote as the populace use it to declare their dissatisfaction with Prime Minister Renzi and his Partito Democratico (Democratic Party) led government.

Our base case scenario is for a narrow ‘No’ vote and rejection of the electoral and constitutional changes, and while Renzi has said he will resign, we will likely see the President seek to install a caretaker prime minister to lead a technocrat government until scheduled elections in May 2018. We believe this is currently priced into Italian spreads, although we would likely see a widening in spreads if a significant defeat for Renzi leads to increased speculation regarding early elections (particularly given the significant gains recently of the populist Five Star Movement).

Rowena Geraghty – Standish, a BNY Mellon company

Italy will hold a much-anticipated referendum on constitutional change on the 4 December. While the passing of the referendum would bring greater electoral stability in the future, there is an increasing risk that the referendum will result in a ‘No’ vote as the populace use it to declare their dissatisfaction with Prime Minister Renzi and his Partito Democratico (Democratic Party) … read more

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Why not all inflation measures are created the same

Central banks have long adopted inflation targeting on the premise that low and stable inflation will promote long-term economic growth. But in our view there are inherent problems associated with inflation targets, particularly when it comes to deciding which inflation measure to use.

The Federal Reserve (Fed), for example, targets the price inflation measure for personal consumption expenditures (PCE) at 2%. Like most central banks, the Fed targets the core inflation measure, arguing that volatile factors such as food and energy prices should be stripped out.

But, what if core PCE is giving a misleading picture of inflationary pressures in the US economy? Each measure of price inflation has components that are weighted differently and the sensitivity of each to the business cycle can vary. Some sectors may also be more prone to experiencing large idiosyncratic shocks compared to others. Other forms of aggregation can be used, further complicating the picture.

The suggestion that the inflation target itself may be flawed is interesting, given the effort investors pour into dissecting every line of monetary policy communication from central banks for clues as to the next move in interest rates or, as the case has been more recently, unconventional policy settings. The issue reminds this fund manager of Goodharts law, named after Charles Goodhart a former advisor to the Bank of England who first opined in 1975 that “when a measure becomes a target, it ceases to be a good measure”.

David Hooker – Insight, a BNY Mellon company

Central banks have long adopted inflation targeting on the premise that low and stable inflation will promote long-term economic growth. But in our view there are inherent problems associated with inflation targets, particularly when it comes to deciding which inflation measure to use. The Federal Reserve (Fed), for example, targets the price inflation measure for personal consumption expenditures (PCE) at … read more

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Factoring in US growth expectations

In the US, economic growth rebounded in the third quarter however the sources of this growth appear transitory. GDP grew at 2.9% annualized in the third  quarter of 2016, following sub-2% growth the three previous quarters. Weakness in inventory accumulation and export growth had been a major drag on growth before the third quarter. A jump in both series this quarter may reflect a rebalancing effect rather than a sustainable change in GDP trend growth. Nevertheless, we revised up our US GDP forecast over the next year to 1.9% from 1.7% which is below many commercial forecasters. We currently assign a probability of about 61% of below 2% growth, a 39% probability of 2-4% growth and essentially zero weight on above 4% growth.

At the November Federal Open Market Committee (FOMC) meeting, the US Federal Reserve decided not to raise its target federal funds rate. In its press release the FOMC stated that “some evidence” was already apparent towards its objectives implying that some current data already points to a rate rise. Also the revised dot chart forecasts one rate rise in 2016 and at least two in 2017. We believe the FOMC came close to “broadcasting” a strong desire to increase rates in December 2016. We thus maintain our forecast of a rate hike at the December meeting.

Karsten Jeske – Mellon Capital, a BNY Mellon company

In the US, economic growth rebounded in the third quarter however the sources of this growth, inventories and exports, appear transitory. GDP grew at 2.9% annualized in the third  quarter of 2016, following sub-2% growth the three previous quarters. Weakness in inventory accumulation and export growth had been a major drag on growth before the third quarter. A jump in … read more

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US election: Winner takes all?

Elections matter, especially when the choice offers distinct and unpredictable governing outcomes. Here, we consider four election outcomes following 8 November and how they might affect the US political, regulatory and economic landscape.

(1) President Clinton and a Democratic House and Senate

A uniformly Democratic Congress will probably reveal how quickly the gears of the government can mesh. The last time this happened, President Obama signed the American Recovery and Reinvestment Act the month after his inauguration in February 2009. Capitol Hill most likely tugs the White House left of the president’s more centrist leanings, a process that already began during the nomination contest.

(2) President Clinton and a split Capitol Hill

Given the advantage of incumbency, the most likely outcome is a divided government, where President Clinton has to work with a Republican House. An advantage is that she will have leverage that comes from a Senate run by a Democratic majority. Control of the Senate provides the president with some freedom in nominating appointees to her liking, but the voting margin there seems likely to be sufficiently slim that procedural manoeuvring will make some of those nomination battles dramatic. Expect progress on corporate tax reform, some spending on infrastructure, and a preservation of the regulatory infrastructure erected over the past eight years.

(3) President Clinton and a solidly Republican Capitol Hill

With Capitol Hill run by the opposition party, President Clinton will have to curb her party’s ambitions on appointees and compromise on legislation. Look to key appointees, whenever they are finally confirmed, to be well right of the Clinton campaign’s talking points. The major legislative initiatives of the White House may well be the exercise of veto power. Tighter gridlock than we have known before makes it likely that there will be no meaningful progress on tax reform nor an increase in infrastructure spending.

(4) President Trump and a Republican House and Senate

Under an all-Republican outcome, the same party controls the White House, the House of Representatives, and the Senate, but the president, speaker, and majority leader are not really on the same page about policy. The need to show progress will drive them to some compromises, picking the low-hanging fruit common to all involved.

Fiscal stimulus kicks in quickly, with more spending on defence and infrastructure and a restructuring of corporate taxes. After that, expect the slow crawl of tax reform, designed by the speaker to be acceptable to the president. Meanwhile, the White House will be using its executive authority to scale back the nation’s position in international trade.

By Vincent Reinhart – Standish, a BNY Mellon company

Elections matter, especially when the choice offers distinct and unpredictable governing outcomes. Here, we consider four election outcomes following 8 November and how they might affect the US political, regulatory and economic landscape. (1) President Clinton and a Democratic House and Senate A uniformly Democratic Congress will probably reveal how quickly the gears of the government can mesh. The last … read more

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The will they/won’t they moment for US populism

The populism that appears to have underpinned the UK’s Brexit result is a global phenomenon and one that Donald Trump has successfully exploited, by presenting himself as the anti-politician. But when analysing the US election in terms of its investment implications, the only certainty about the outcome is uncertainty.

Despite Hilary Clinton maintaining a narrow lead in the polls, the lesson of Brexit is that this is by no means a foregone conclusion. From a policy perspective the debate is markedly different from those of recent US elections. In listening and responding to the populists Trump, along with Bernie Sanders before he dropped out of the democratic nomination contest, has shifted the policy landscape to the left.  Clinton has responded to the growing populism by publically attacking pricing strategies of drug companies, weighing on the share price of pharm companies.

Volatility leading into the election is to be expected given the uncertain outcome and some of the extreme views being proposed by the two leading candidates. Enforcing any sort of haircut on Treasuries would be negative for the asset class should Trump win. The healthcare service sector could be a key beneficiary of a Clinton victory given her focus on drug pricing. Should Trump win then pharmaceuticals and drug devices would rally. Infrastructure-related stocks, construction and house builders could be beneficiaries of either candidate winning, given the huge financial pledges behind a drive to upgrade the US’s creaking infrastructure.

Suzanne Hutchins – Newton, a BNY Mellon company

The populism that appears to have underpinned the UK’s Brexit result is a global phenomenon and one that Donald Trump has successfully exploited, by presenting himself as the anti-politician. But when analysing the US election in terms of its investment implications, the only certainty about the outcome is uncertainty. Despite Hilary Clinton maintaining a narrow lead in the polls, the … read more

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