The FED expects inflation figures to pick up throughout the year and hence no significant move was telegraphed on yesterday’s FOMC statement. On the other side of the world, Croatia got an outlook upgrade last Friday from Moody’s, but the rating itself remained unchanged at Ba2 (equal to BB in S&P/Fitch terms), two notches below investment grade. Oh, and have You noticed that according to Moody’s there isn’t a single country rated Ba1 (BB+ in equivalent terms)? Investment grade might be closer than You think…
In December the PCE core change has been @ 1.95% and in the first three months of 2019 this inflation gauge has drifted away (1.6% YoY in March) from FED’s target (2.0% YoY); according to yesterday’s FOMC statement, that doesn’t concern the FED very much. Markets think the same way as the FED does since 5Y5Y inflation swap rests @ 2.25% (FWISUS55 Index on Bloomberg), and the FOMC deemed the factors at work as “transitory”. Also, it seems that issuance of US government securities and tax receipts kicked off cash hoarding of financial institutions into the central bank account, so the FOMC acted to cut the upper bound by some 5bps. Apart from these two things, there wasn’t much signal about the direction of interest rates and at this point it seems that we have a divided FOMC. Markets haven’t reacted that much to the FOMC statement – 10Y Treasuries edged upwards in the wake of the statement (probably to traders betting on an increase of rate cut probability) but erased all of the gains after it became clear the FED sticks to it’s belief that inflation trend would eventually turn around. The FED fund futures haven’t made any significant move at all, and the January 2020 FED fund futures trades at an implied yield of 2.225% (“FFF0 Comdty” on Bloomberg) – hence the market bets that the next move is going to be a cut, and it’s getting closer and closer.
Now to a more local news – after Standard & Poor’s Global Ratings decided to bring Croatian sovereign rating back into investment class (March 21st), on Friday Moody’s made a step in the same direction and changed the outlook from stable to positive. The rating itself has remained unchanged at Ba2 – the same level as Georgia and Azerbaijan, two notches below Romania, Russia and Hungary; still the outlook upgrade is certainly a step in the right direction. The agency praised Croatian efforts to bring the pension system in check, as well as recently achieved budget surpluses which managed to overcome challenges such as Agrokor (2017) and shipyards (2018). Apart from the fiscal blueprint, solid GDP growth figures are likely to continue in 2019-20, when GDP growth is expected to settle around 2.4% YoY (corresponding to potential GDP growth). The agency also mentions that tourism makes up 20% of GDP and about 35% of export revenues, making Croatian economic output sensitive to less favourable external environment, but country’s firm anchoring on the European tourism landscape raises the certainty that tourist inflows will continue in future as well. Finally, the process of accession into the euro area serves as a policy anchor and would contribute to further institutional reform. The agency mentioned that Croatia still has an above Ba-median public debt relative to GDP (very high share of FX debt is also a reason for concern), but the trend is favourable and by 2020 this ratio will likely drop to about 70% GDP. So not quite investment grade, but we’re getting there.
Croatian Eurobonds haven’t changed this morning and it’s worth noting that the shortest Croatian USD international bond trades at YTM below 3.00% for quite some time. The best executable bid on the market is 101.85 (2.97%), but with a bit of patience and luck sellers might get 101.95 (2.78% YTM). What to do with the proceeds is a question worth pondering because the USD curve is as flat as it gets – but from the G-spread perspective CROATIA 2023 USD might be the place to be as it offers some 90bps premium on the US paper of equal maturity. Also, looking back at the yield curve, CROATIA 2023 USD gives 5.5bps of extra yield on every year of additional duration (3.18% – 3.07%, divided by two), but the steepness is still higher between CROATIA 2020 USD and CROATIA 2021 USD.