This week looks set to provide markets with an update on the trade war theme as President Trump’s proposed tariffs face extensive discussion in the US. Elsewhere, the general status of the USD rally will be in focus as the EURUSD bounce nears 1.2000.
The latter half of last week saw the USD weaker and risk appetite continuing to improve, perhaps as the lid was kept firmly on US yields after a small negative surprise on the US April CPI data and after a trio of Treasury auctions that included a solid 10-year and 30-year result. Geopolitical drama was shrugged off as nearly always, including the increasingly hot confrontation between Israel and Iran on Syrian soil after the US dropped its commitment to the Iran nuclear deal.
In Italy, it appears that the two populist parties will cobble together a ruling coalition that the market somehow sees as putting zero existential strain on the single currency. Italian to German 10-year yield spreads, while much wider than those for Spain-Germany (around 132 basis points for the former versus 72 bps for the latter). Apparently, optimists believe either that the coalition will be mostly derailed in implementing anything dramatic by their lack of synergy or by political reality, but for the longer haul, this is a dangerous assumption. Italy’s debt trajectory is entirely unsustainable and the most interesting idea from either of the two parties in power is the Lega’s interest in studying ways to issue new bonds (so-called “mini-BOTs”) that are backed by tax revenue and would effectively act as a kind of parallel currency – something that is entirely outside of the EU legal framework.
Regardless of the specific trigger, the next recession in Italy guarantees some sort of showdown with the EU with these two parties in power.
The focus this week looks rather diffuse, with lots of action on the economic calendar but few standout event risks. Among these are the three days of hearings scheduled from Tuesday to Thursday in the US at the trade representative’s office on threatened tariffs. the clock is winding down on whether these will be implemented and the “trade war” theme could quickly re-emerge. Otherwise, we have a number of Fed and ECB speakers out all week jawboning as one of the most relevant macro indicators – the flattening of the US yield curve – continues to grind away as long as a) short rates remain elevated and the Fed continues to hike rates and b) the longer end fails to break through the 3.00% resistance level for the 10-year benchmark.
Finally, we are awed that the major equity indices have managed to claw to local highs despite the strong growth headwinds from higher oil prices, the geopolitical noise, etc cetera. Current levels don’t look likely to last as we are either set for a rapid extension higher or a rejection of the recent break.
EURUSD is a reasonable proxy for the status of the USD rally as the pair found support mid-last week below 1.1850 and could eye the 1.2000 big round level or possibly the 200-day moving average for local resistance levels, but bulls can’t really take heart until the pair has worked back above the pivot zone on the way down at around the 1.2200 level. This sell-off has been sufficiently deep to throw the entire chart into neutral in the bigger picture until the bulls prove themselves.