Divyang Shah, IFR Senior Strategist
At the start of September the markets were looking at some significant event risks that were navigated with ease as the outcomes were better than expected. The new month/quarter brings with it two uncertainties in the form of budget battles in Washington and Italian political uncertainty and they too look likely to end with better than feared outcomes.
At the beginning of September we were looking at two significant risks on a calendar that was filed with event risks. The new month/quarter has delivered a new set of uncertainties but so far the market has been able to digest them without much of an increase in volatility.
Concerns that the current US government shutdown could be a repeat of 2011 are eased by the fact that:
1) the economic data has not been coming in weak as we saw with the Fed tapering expectations back in September
2) the Fed is currently engaged in US$85bn worth of QE and
3) the novelty value of a shutdown is less as back in 2011 it had been 15-years since the last shutdown in 1995/96. The data and the monetary policy backdrop provide a lot of comfort.
The US government shutdown simply focuses minds on the more significant battle/deadline of Oct 15/17 when the US Treasury is expected to run out of accounting manoeuvres and hit the debt limit. It seems very unlikely that either the Democrats or Republicans would allow the US to default (even technically) even if they do take things down to the 11th hour.
Italian politics has always been an unknown but we seem to have returned to the old days of governments lasting less than a year. Without a new electoral system there does not seem to be an appetite for early elections even if Berlusconi seems intent on trying to force one through. The most likely scenario is that the PDL will split and whether it’s the existing PM Letta or another figure a government will be bandaged together to focus on the 2014 budget and meeting fiscal targets.
The level of uncertainty is likely to ratchet higher on both the US and Italy over the coming days but ultimately we are likely to navigate these risks with ease by month-end. The most significant of the September risks looks unlikely to enter the radar screens until December when a Fed tapering seems more likely than in October. Given the dismal failure in predicting the September taper we will need clearer guidance and signals from the Fed before a December tapering becomes a central scenario.
The preference is to use the uncertainty heading into mid-October to re-establish shorts and curve steepeners on bonds as well as paying 12x24 SONIA forwards.
