* Investors wait to see how aggressive US Federal Reserve will be in raising rates, with fears that a bigger hike could tip the economy into recession * Italian bond yields tumble, euro rises as ECB set to discuss bond turmoil Schmieding goes on to say: MIND THE FUNDAMENTALS: Some spread widening amid an overall rise in yields is normal. As long as it remains consistent with the inflation backdrop and the pace of nominal growth, it should not present an imminent risk even for fiscally challenged Italy. We expect inflation to settle around 2.5% eventually. Adjusting for such an inflation forecast, the real financing costs of Italy are still quite bearable. Inflation lifts tax receipts and reduces the real value of outstanding debt. WALKING A TIGHTROPE TO A SOFT LANDING: Engineering a soft landing for economies battered by external shocks and facing the highest inflation in decades will be as hard as it sounds for all major central banks. The extra challenge for the ECB is that its policies affect borrowing costs in 19 economies with different fundamentals. PERIPHERY UNDER PRESSURE: Even before the European Central Bank (ECB) has hiked rates, Italian, Greek, Spanish and Portuguese spreads versus German bunds are widening amid a broad-based tightening of financial conditions across the Eurozone. With memories of the European debt crisis still fresh, investors are asking how and under what circumstances ECB president Christine Lagarde would deliver on the promise she made in her blog from 23 May to act against “excessive fragmentation” if required after the end of net asset purchases. Markets sold off after the ECB’s monetary policy statement last Thursday referred only vaguely to a “flexible” use of instruments to safeguard the transmission of monetary policy. In an emergency meeting today, the ECB may finally reveal its hand. Continue reading...
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