Macro: Sandcastle economics
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Cautious enthusiasm for Italy’s budget gambit
John J. Hardy
Chief Macro Strategist
Summary: The Italian government has lowered its forecasted budget for 2020 and 2021 in a bid to get its 2019 proposals passed – a clever move to pass measures now and pretend that fiscal probity will improve later. The market is cautiously hopeful.
The euro rebounded this morning on Italy’s latest move to shore up its fiscal credibility as the government claimed it could reduce the deficit projections slightly from 2.4% for both 2020 and 2021 to 2.2% and 2.0%, respectively. This comes after yesterday’s rather tough response from the EU side and the markets jettisoning of Italian BTPs, which took the 10-year sovereign Italian yield to above 3.5% and the 2-year above 1.5% at one point. This is a rather clever move, as it provides the optics of compromise without really putting anything new on the table, as budget projections rarely pan out anyway, particularly with new fiscal stimulus measures in the works.
The markets are cautiously hopeful, given the 2-year BTP yields trading 25-35 basis points below yesterday’s highs and EURCHF rebounding back above 1.1400 this morning from yesterday’s lows below 1.1315. But will the EU commission budge as it fears setting a dangerous precedent for populists elsewhere? Let’s see – but governments at the core will eventually have to move to a more expansive stance to keep the populist threat at bay – the difficulty is determining the timeline – but 2019 EU parliament elections are moving onto the radar for next May.
UK Conservative party character-in-chief Boris Johnson stopped short of challenging Prime Minister May of leadership of the party in a speech yesterday, but railed against the Chequers plan and begged the prime minister to revert to her original Brexit goals. May’s latest update to her stance will hit the wires today at 10:30 GMT as she speaks at the conference. A more aggressive stance that is unlikely to mean a deal with the EU can be struck won’t necessarily prove GBP-negative if the sense is that the Tories will never deliver Brexit and we end with an extension of the negotiation period and the unknown of either an eventual election or second referendum.
Elsewhere, US Fed Chairman Powell delivered a speech yesterday in which he saw little risk of aggravated rises in inflation from an overheating labour market, saying that the combination of very low unemployment rates and steady, low inflation points to “extraordinary times”. But given that Powell has previously suggested that it is not inflation, but financial stability risks that are the chief risk to the economy, and given that high yield bond spreads are by some measures the lowest they have been since the global financial crisis, suggesting that financial conditions are as easy as ever, this Fed is likely to continue to provide steady rate hike pressure for now.
Chart: EURCHF
EURCHF is fibrillating in the range below the prior notable pivot around 1.1440. It seems clear that if the EU and Italy can put off the budget showdown for another year and EU core rates can move back toward a normalisation path higher, that EURCHF would look higher, potentially blasting all the way back into the 1.1800-1.2000 range if the 1.1440-1.1500 pivot zone hurdle can be cleared.
The G-10 rundown
USD – the greenback is trading indifferently here, with the next key test this Friday’s Sep. Average Hourly Earnings data after the August print reached a new high for the cycle. Given Powell’s words, it might take a considerable upside surprise to drive USD gains.
EUR – we simply have to get over this Italian budget hurdle with BTP yields remaining rangebound or better and EU core rates back on a normalisation track to engineer a more sustained euro rally.
JPY – the yen may move in negative correlation with the euro on the latter’s ability to overcome the Italian budget showdown, or not…EURJPY is very headline prone.
GBP – sterling is eyeing Prime Minister’s speech at the Tory conference today for an update on any changes to her negotiation stance after the impasse with the EU in the latest round.
CHF – we discuss EURCHF above, but USDCHF has been on a steep trajectory higher as well and gets very technically interesting as parity approaches again.
AUD – the Aussie is languishing amid non-existent policy expectations from the Reserve Bank of Australia and concerns about China’s intentions for the renminbi during a week when China’s markets are closed.
CAD – we like CAD, with the tricky bit being where to express the upside – versus the USD or versus JPY or even CHF or AUD? USDCAD is the most straightforward trade if the pair remains clear below the 1.2900 recent break.
NZD – little to go on here as we await a relative strength move versus the AUD for the kiwi to deserve attention. The latest milk auction was a slight NZD negative as prices fell slightly from the previous auction and are at the lower end of the two-year range.
SEK – EURSEK is pushing back lower after squeezing up above 9.400 – bears will want to re-engage here as long as we remain well below 10.45.
NOK – NOKSEK is having a go above the huge 1.1000 level yesterday, an interesting measure of relative strength as oil prices bulling up to 85 dollars/barrel have favoured NOK even more than SEK recently. A range high at 1.1042 has not yet been cleared there. Given that we like both NOK and SEK, we’re agnostic there, but like expressing NOK strength versus the EUR and even the USD on a technical basis.
Upcoming Economic Calendar Highlights (all times GMT)
09:00 – Eurozone Aug. Retail Sales
10:30 (?) – UK Prime Minister May at Tory Conference
10:30 – US Fed’s Evans (Non-Voter) to Speak
12:05 – US Fed’s Barkin (Voter) to Speak
12:15 – US Sep. ADP Payrolls Change
14:00 – US Sep. ISM Non-manufacturing Survey
14:30 – US Weekly DoE Crude Oil/Product Inventories
18:00 – US Fed’s Brainard to speak
20:00 – US Fed’s Powell to speak
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