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September
22
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Week In Review

Fed

As expected, the Federal Reserve Open Market Committee (FOMC) announced its decision to maintain the federal funds rate at the current target of 1% to 1.25%. According to the Fed statement, the labor market continued to strengthen and economic activity has been rising moderately. The committee noted that business investment has picked up in recent quarters, and inflation is running somewhat below the committee’s 2% longer-run objective. The Fed also announced that it will initiate its balance sheet normalization program in October. Balance sheet normalization will begin by allowing $6 billion of Treasury maturities and $4 billion of MBS pay downs to roll off each month.

Our Take

There was no surprise to the Fed’s decision to hold rates steady, and it remains committed to “gradual adjustments” in the fed funds rate. The next step in removing accommodation is now balance sheet normalization, which will begin next month. The Fed has put a staggering amount of money into the system, and normalizing monetary policy from here will prove to be difficult.


China Downgrade

S&P Global Ratings cut China’s sovereign rating from AA- to A+ and also reduced the ratings of three foreign banks with large China operations. S&P cited China’s significant increase in leverage since the financial crisis as the main reason for the downgrade.

Our Take

S&P’s downgrade follows a similar action taken by Moody’s earlier this year. These downgrades reflect growing concern that China will have difficulty deleveraging its economy without significantly reducing growth.


Oil

The IEA reported that excess crude inventories have declined by 28% since the beginning of the year as a result of the output cuts by OPEC and Russia. However, the IEA forecasts that seasonal demand fluctuations and increased production in 2018 will cause inventories to begin rising again next year.

Our Take

As the cost structure of U.S. shale production continues to improve, OPEC is finding itself unable to drive oil prices up from current levels without surrendering increasing amounts of market share. Unless something changes the trajectory of U.S. shale production, oil prices are unlikely to rise above current levels for an extended period of time.


Brexit

May gave a speech in which she committed the UK to accepting a transition period following Brexit, during which the UK would comply with all EU regulations, allow the ECJ jurisdiction in the UK, and meet all financial obligations in exchange for access to the common market.

Our Take

Today’s speech was a concession to the fact that negotiations are not proceeding quickly enough to avoid a hard Brexit with no trade deal in place by March of 2019. The EU’s response to this speech will indicate whether they want to reach a deal or make an example of Britain to deter other countries from leaving the EU.


Municipals

S&P Global Ratings downgraded Pennsylvania’s general obligation debt rating from AA- to A+ this week. S&P cited the commonwealth’s structural imbalance and the late budget as reasons for the downgrade. Pennsylvania lawmakers remain at odds over the budget. The Pennsylvania Senate passed a budget plan in July that included borrowing and new taxes. The Pennsylvania House did not vote on the budget before lawmakers left for summer recess. This week, the House returned and passed its own budget plan, which included no new taxes. The Pennsylvania Senate then rejected the House proposal. Democratic Governor Tom Corbett remains optimistic that the Republican controlled Senate and House will reach a budget agreement by October 1.

Our Take

Pennsylvania has struggled with a budget deficit dating back to 2012. S&P lowered Pennsylvania’s rating in 2014 from AA to AA-. Pennsylvania cannot afford to have the budget stalemate continue. Municipalities and school districts that depend on aid from the commonwealth continue to wait for funding. Lawmakers must reach a compromise to end the impasse.