Weekly house view | Italian bank taxes, yes and no

Last week, markets were treated to a relatively benign US consumer price index report for July. True, consumer inflation remains above the Federal Reserve’s 2% target, and the July producer price index came in higher than expected. But on balance we think the drop in core consumer inflation will convince the Fed to keep policy rates on hold in September. However, while we do not expect another rate hike, we do believe the tone of the minutes from the Fed’s July policy meeting to be released this week will continue to have a hawkish bias, especially as inflation expectations show signs of rising again. This rise is largely due to a rise in oil prices. Given our expectation that undersupply will lift Brent crude oil beyond USD100 by year’s end from around USD86 today, this is certainly an area to watch. 

China’s inflation problem is of a different order. The headline consumer price figure for July (-0.3% year on year) indicated that the country has fallen into deflation. Indeed, negative news flow from China dominates. Last week this included a big drop in July trade figures and further woes in the heavily leveraged property sector. China’s largest property developer by sales missed coupon payments on two international bonds and trading halted on other bonds. The blow to investor confidence and the risk of contagion cannot be overstated. While the Chinese property sector might be considered a special case, the events unfolding there help explain why we remain underweight noninvestment-grade corporate bonds overall. Indeed, the problems of noninvestment-grade property-related debtors is not confined to China, with a high-profile US office-space company admitting there was “substantial doubt” it could continue its operations. 

The Q2 earnings season has proved generally better than lowly expectations, leading to hopes that we have reached a trough in year-on-year earnings comparisons. But the handsome profits some sectors have reported have not gone unnoticed. Last week, the Italian government imposed a windfall tax on banks. While it had to considerably water down its plans in the face of a negative market reaction, one-off levies are set to become another source of unpredictability for investors. As we put it in one of our investment themes for this year, ‘accidents will happen’!