Italy’s Budget Deficit

Italy has been creating some volatility in financial markets.

The suggestion from Claudio Borghi, head of the lower house budget committee, that Italy could solve its problems with its “own currency,” followed up with a quick denial that this meant that there were plans to "leave the euro" were enough to affect Italian bond yields with the Italian 10-year yield rising 14 basis points to 3.44 percent, the highest since March 2014. The spread over their German peers climbed 20 basis points to 302 basis points while the euro dropped as much as 0.6 percent to $1.1505.

Investors could do well keeping in mind that the chances of Italy leaving the euro are extremely low given the huge costs that would be involved. Economic costs are perhaps the least significant. Political and social costs are far higher.

The key signal for whether anyone really takes the threat seriously would be bank runs. If Italians seriously think that Italy could leave the euro, then they should sensibly take euros out of Italian banks as quickly as possible. This is not happening.

Italy’s deputy Prime Minister Salvini speaks today. The Italian deficit to GDP ratio came in at -0.5 percent in the second quarter of 2018, compared with the earlier reading of -2.1 percent in the second quarter of 2018.

Powell's Speech

Fed Chair Jerome Powell gave a much-awaited speech titled “Monetary Policy and Risk Management at a Time of Low Inflation and Low Unemployment” declaring wage rises are consistent with the idea that the U.S. labor market is not overheating.

The speech reads: “… Many factors, including better conduct of monetary policy over the past few decades, have greatly reduced, but not eliminated, the effects that tight labor markets have on inflation. However, no one fully understands the nature of these changes or the role they play in the current context. Common sense suggests we should beware when forecasts predict events seldom before observed in the economy…”

That is probably true, but whoever wrote the speech shows perhaps a little bit more faith in the accuracy of wage measurement in the United States than the realities of a rapidly changing economy would warrant.

Wage growth may not accurately reflect compensation for employment in a world with more self-employment, for example.

The comments that Powell gave in his speech do not suggest that the Federal Reserve is looking to reduce inflation with an aggressive monetary policy, but they are consistent with further rate hikes to keep inflation ‘around’ current levels.

Powell’s speech reads: “Wages and compensation data are one important source of information. These measures have picked up some recently, but in a way that is quite welcome. Specifically, the rise in wages is broadly consistent with observed rates of price inflation and labor productivity growth and therefore does not point to an overheating labor market. Further, higher wage growth alone need not be inflationary.”

Interestingly, Amazon announced it raised the minimum wage to $15 for all its U.S. employees, including full-time, part-time, temporary, and seasonal.

Of course, Amazon’s move is unlikely this to have a major impact on either aggregate wage growth over the median term or on the inflation pressures in the economy.

U.S.-China Trade Tensions

White House chief economic adviser Larry Kudlow said trade talks between the U.S. and China could resume when policy makers meet in Buenos Aires, Argentina for the Group of 20 meeting on October 30 - December 1.

Mr. Kudlow also said that no formal plans have been made to resume talks, but that U.S. officials are ready to negotiate as long as the conversations are serious and added that U.S. officials remain concerned about a number of trade barriers in China, including tariffs, joint ownership requirements for American companies, and “the theft of intellectual property.”

Emerging Markets - Turkey

Turkish consumer price inflation rose to 24.52 percent year-on-year in September, the highest level since August 2003, as the impact of a currency crisis continued to hurt the economy. The sharp increase in inflation came in despite a 625 basis points hike in interest rates to 24 percent on September 13th.

The Turkish lira is currently at about 6.05 TRY to the dollar and about 40 percent lower since the beginning of the year.

In my opinion, investors could do well remaining on the sidelines for Turkey as well as for most of the emerging markets (EM) because the worst may be yet to come.

Etienne "Hans" Parisis is a bank economist who has advised investors on financial markets and international investments.