Head of FX Strategy
Summary: We see the Italian budget standoff with the EU nearing climax, the UK Tory party divided and thus less likely to force through a 'hard Brexit', and relief concerning Canada and its finally signing a trade deal with the US.
The general message from EU representatives like Economic Commissioner Moscovici is that the budget rules must be obeyed. Others like Juncker have also chimed in while Italy’s Di Maio and Salvini have nothing to lose in completely refusing to budge, with Di Maio calling the EU agencies behaviour a kind of terrorism.
The populists feel they are unlikely to be harmed by a further impasse, which could lead to new Italian elections and who knows, a call to finance some of the government’s desired programmes with a parallel currency? Does the EU really want to take the situation this far and risk a new government in Italy with a strong Lega component and an even more emboldened Salvini? Apparently, the EU game plan is to hope that the bond market will cow the Italian populists as BTP yields spike out of control and the Italian public loses confidence in FSM and Lega. It’s a risky gambit.
The longer term inevitable answer to all the situation in Europe will have to be a fiscal expansion across Europe if the EU is to stay together as a functioning entity and keep the populists at bay. But do we have a crazy, one-off spike in Italian yields and other mayhem first? Regardless, the EURUSD sell-off could have a fairly short date to expiry… we are rapidly nearing the climax of this situation and we see very high potential two-way risk in the nearest term as the headlines roll in.
Wherever EURUSD bottoms out, the bounce will inevitably prove a hard one if fiscal rides to the rescue.
The Tory party conference will wind down tomorrow, with Brexit hardliner Boris Johnson set to deliver a speech today to the conference and many wondering if BoJo is ready to finally challenge May for party leadership rather than criticising and clowning around at the margins. Sterling doesn’t seem to view the conference with much trepidation as a dysfunctional and divided Conservative party means lower odds of a hard Brexit and higher odds of a negotiation period extension and eventual second referendum. There are some risky assumptions in the mix, and we prefer to steer clear of drawing any conclusions on sterling.
CAD crosses have seen the most volatility over the last couple of sessions on the relief rally in CAD on the signing of the “USMCA” trade deal. As well, a bit of pent-up demand for CAD might have been building as crude oil prices have ripped higher, even if many Canadian crude grades are sold at steep discounts due to delivery problems into a locally saturated market. The USD looks rather firm at the moment, so CADJPY, EURCAD, and NZDCAD could prove more interesting, but we have certainly seen a big break here that could eventually lead to 1.2500 here as long as we remain below 1.2900.
USD – the greenback fairly firm by default as the focus is on the weak euro and strong CAD and other themes. All eyes on this Friday’s Average Hourly Earnings series for whether we get another rise in US yields all along the curve
EUR – our thoughts above – having a hard time believing that the EURUSD sustains a break below 1.1500 for any significant period of time unless we see both parties in the EU-Italy showdown willing to go into full blown crisis mode.
JPY – JPY picking up a bid against the euro on the latter’s woes and shying away from the 114.00 level in USDJPY.
GBP – trading sideways as we await BoJo’s speech today and May’s position tomorrow. Extension of Article 50 period is our baseline expectation.
CHF – we directionally expect EURCHF to trade like EURUSD with strong interest in longer-dated EURCHF call options if the EU can look beyond Italy and pivot to fiscal.
AUD – the Aussie in a holding pattern after an indifferent RBA meeting with minor statement changes. 2-year Australia rates are a smidge lower and AUDUSD remains in the 0.7200-50 pivot area as China is offline this week on
CAD – the move on the back of the trade deal announcement looks a bit overenthusiastic tactically, but we have broken key areas in USDCAD (200 day moving average, range low – see chart above), so its technically significant . More thoughts on CAD from The Macro Tourist https://www.themacrotourist.com/posts/2018/10/01/usmca/ . I am largely sympathetic to the post, especially for near term CAD potential in non-USD pairings (long term NZDCAD chart interesting).
NZD – no spin at the moment here. Still prefer AUDNZD higher, longer-term.
SEK – the krona disliking the EU existential aggravation – providing better entry levels for EURSEK shorts assuming things eventually work out
NOK – $85/barrel Brent dominating EU fears and keeping NOK on the bid.