Italy – Uncertainty postponed
In Italy, Sergio Mattarella has been re-elected as President, after one week of political negotiations which failed to deliver a viable alternative. The outcome is a positive for Italian risk assets. As Draghi was not elected, chances of early elections are avoided and the government can continue its work on the pandemic and the recovery fund. Further, the credibility of the incumbent President may shield Italian assets at least partially from volatility in the run-up to 2023 elections. Finally, Mattarella is as at his second mandate, suggesting this arrangement does not rule out Draghi as next President after next year elections, if political conditions allow. The immediate impact on BTPs and Italian assets has been limited, as not many priced chances of political uncertainty as a result of this election. The next 12 months, instead, could be bumpier. The ECB now holds 35% of Italian debt, and gradual tapering in 2022 may be followed by hikes in 2023. Elections are on the horizon in 2023, and right-parties cumulatively score 40% in the polls, suggesting some tail risk of non-market friendly discussions being back on the table at least into the political campaign. The election thus provides a good insurance against monetary and political risks coming up.
Fed – Calibrating hikes
The first Fed meeting of 2022 prepared the market for the upcoming hiking cycle. On January 26th , Chairman Powell guided explicitly for multiple hikes in 2022, not ruling out the possibility of hiking at consecutive meetings. Importantly, risks coming from recent equity market volatility and the pandemic were downplayed. Quantitative tightening was also discussed as a natural follow-on from hikes. Finally, FOMC members after the meeting have opened the door to the possibility of one 50bp hike to start the cycle if inflation conditions warrant. Following the meeting, market pricing of hikes increased to 5 in 2022. The Fed is gradually converging to a more worried attitude towards inflation. Stability in commodity markets in November and December did not attenuate inflationary pressure, and service inflation is gradually catching up with goods. At the same time, the US administration is making clear that inflation is now a political priority. We share many of the recent Fed concerns about inflation, but think many market calls for 7-8 hikes are probably a bit exaggerated. 4 hikes would send the right message without over-stretching, and are thus the most likely scenario in our view. Market-wise, the front-end is now appropriately priced for hikes, but the long-end and belly are not. Long-term US yields remain more than 2% below the Fed 12-months inflation projections, and both the Fed and consensus now expect inflation to drop towards 3% in 2023. As the Fed gets closer to tightening and the first hikes materialize, steepening pressure on US curve may be set to increase, further extending the recent selloff from Treasury to other areas, such as equity and credit.
ECB – It’s not time to make a change…
On Thursday, we do not expect the ECB communication around monetary policy to change substantially. Guidance for PEPP tapering will be updated, but the pace is likely to be kept flexible at least for a few months. On inflation, the ECB is unlikely to sound an alarm bell. Second-round wage effects remain subdued, and the transitory narrative was never fully abandoned. A softening path can thus still be suggested by the ECB, especially as supply bottlenecks continue to ease. The impact of energy prices on inflation may be a controversial issue, given the fluidity of the situation at Ukraine borders. The attitude on hikes is likely to remain similar to 4Q21, with President Lagarde guiding for no hikes in 2022 and inflation-dependent moves in 2023. Overall, the ECB seems in no rush to move to a tighter stance. Inflation is higher than history but not as high as in the US, and the large buildup of debt in periphery makes inflation tolerance higher than global peers. The pressure on market rates and spread somewhat increased over the past three months, but remains largely under control. The ECB may thus kick the tightening can a bit further down the road, and wait for more peer pressure from the Fed to act more decisively. We remain of the view that inflation and global hikes will force a tighter stance than the market expects, but probably we will see concrete signs of this closer to summer or after the first Fed hike.
Alberto Gallo – Portfolio Manager Global Credit Opportunities Fund
Gabriele Foà – Portfolio Manager Global Credit Opportunities Fund
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