Head of FX Strategy, Saxo Bank Group
Summary: Italy’s populist government has declared the intent to run a 2.4% budget deficit for the next three years, higher than previous estimates and a key test for Italy’s government debt market and EU existential questions.
Italy’s populist government has declared the intent to run a 2.4% budget deficit for the next three years, higher than previous estimates and a key test for Italy’s government debt market and EU existential questions. EURCHF looks most sensitive to developments there after a rally attempt. Elsewhere, the USD swings back to selective strength.
The drama around the Italian budget planning process is the dominant focus this morning. Yesterday, Italian BTPs rallied stronger in a vote of confidence that, despite populist proclamations, a smallish budget deficit would win the day. But the news late yesterday that the populist government would pursue a 2.4% deficit in 2019 and added insult to BTP injury with defiant rhetoric (vowing not to be held “hostage” to markets – although every country is a hostage to markets and possibly for the ensuing two years rattled confidence in Italian debt and the euro.
EURCHF put in a strong rally yesterday that is suffering a setback since the news of the larger deficit broke. It looks like the 100 basis point level is an important one for Italy’s two-year BTP – it closed yesterday at 75 basis points before the yield jumped higher at the open today and traded above 100 basis points as of this writing. The chart below illustrates the significance of the 100 basis point level, which looks like an important one to maintain to keep a lid on the situation.
Chart: Italy’s two-year BTP yield
The CHF bears risk a false start here as Italian BTPs are getting thrown overboard this morning on the news of the larger budget deficit. The EU existential worries look best expressed through EURCHF, which needs to avoid a reversal back through the 1.1300-50 zone to avoid a plunge back into the old range to 1.1200 and lower. A strong close clear of 1.1400 again, on the other hand, together with an orderly Italian BTP market could set the market’s sights on 1.1500+ on the theme of eventual European Central Bank policy normalisation.
Elsewhere, the USD has rallied a bit by default and a bit tough to build a story behind that. US long yields are well off their highs for the cycle earlier this week, and yet USDJPY managed to pop to new highs after mixed data from Japan overnight, including a weak Industrial Production figure for August. Hard to see USDJPY sustaining a rally into the next resistance levels above 114.50 without US yields swinging back higher.
Ahead of the weekend, we have both eyes on Italian BTPs and whether the situation sets in motion a further contagion and real showdown with the EU or whether a bit of market “hostage taking” softens the edges of the populists’ stance. If we get longer term traction on the idea that the EU will have to turn its back on austerity, the 2.4% deficit from Italy would be an easy one to overcome. But we need more signaling on that front from EU governments.
Over the weekend and into early next week, we watch for the degree of UK Conservative Party solidarity on whatever negotiation position it declares before the mid-November EU Summit. The CNY situation remains a nail-biter, but may not see any resolution next week as China’s markets are closed for a national holiday all week. Finally, US PCE inflation today is an interesting test of the post-FOMC reaction in the US dollar and US Treasuries.
The G-10 rundown
USD – the US dollar stronger against most DM currencies, but global risk appetite looks robust and EM currencies don’t appear concerned. The drivers of USD strength here post FOMC are tough to discern, so we are a bit sceptical.
EUR – existential concerns set in motion by Italy’s budget situation – if the lid can stay on Italian yields, the euro may quickly find a new floor.
JPY – if non-Italian yields get back to a rising tendency and risk appetite stays strong, further JPY weakness may lie ahead. Tactically, the USDJPY break higher on a Friday with no support (so far) from the long end of the US yield curve looks odd.
GBP – sterling a bit passive here, but still relatively firm versus the Euro. We await the Tory party conference this weekend. Only full solidarity can deliver a Brexit, otherwise we risk an extension of the negotiation period, elections and possibly a second referendum down the road.
CHF – the proxy for EU existential risks at the moment – still a change for EURCHF to pick up the pieces here if today’s rise in Italian yields is halted quickly.
AUD – may be getting dragged a bit lower by the weak CNY. As well, the RBA is not expected to bring anything new to the table next Tuesday.
CAD – the loonie is bid ahead of today’s latest Canadian GDP data and as BoC’s Poloz expresses confidence that Canada will reach a trade deal with the US.
NZD – ditto from the Aussie comments – NZ rates are dead in the water. As well, the AUDNZD flirt with sub-1.0900 pivots rejected for now – rate spreads AUDNZD mispricing on the weak side.
SEK – one of the few trends going is the SEK repricing higher – Friday’s are often days for lightening up on positions, however.
NOK – EURNOK pushing solidly below 9.50 for the first time since July and we see further potential for downside into 9.40 at least for now, but more to follow later.
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