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Eurozone political woes mount, common currency flounders

Today’s macro highlights:

  • USD - Consumer Confidence Index (May)

Eurozone political woes mount, common currency flounders

As the UK and US return from the extended weekend break, one theme is dominating and that’s the deteriorating political situation across Southern Europe. Italy is facing a constitutional crisis after the President exercised a rarely used veto over the appointment of a new finance minister by the populist coalition. Fears were that, had the post been taken as planned, it would send a clear message over the country’s future intentions with regard to the Eurozone. Withdrawal would potentially be so damaging for investors that the President exercised his right to veto. The Prime Minister has now resigned, a new government needs to be formed and some are calling for the impeachment of the President.

Separately, there’s a vote of confidence scheduled against the Spanish Prime Minister at the end of the week, after a court ruling in a corruption case which involves members of the ruling Popular Party. There’s a lack of consensus amongst opposition politicians as to how execute any ousting so that could count in favour of PM Rajoy, but we’ve seen time and again how markets detest uncertainty. Right now, there’s no shortage of this being seen across the Eurozone.

Leaving the political agenda to one side, high profile economic data is set to be somewhat thinner on the ground today. US consumer confidence figures are arguably the stand out, due for release at 3pm BST and with the country’s economy continuing to fire ahead, expectations are for another good reading to be seen here. Risks may however lie to the downside - US foreign policy is fast moving and although looking positive today, there have been notable detractions in recent weeks. Rising oil prices may also be taking a toll on consumer sentiments, especially as the summer driving season approaches.

It’s also worth noting that US bond yields are falling right now. The 10 year treasuries are yielding well below 3%, a move which has been driven by rising demand (bond yields fall as the underlying price rises). Dovish talk from the Fed plus investors pulling out of Italian government debt have been fuelling the situation in recent days, so regardless of the economic data that’s coming out of the US, its safe haven appeal could well extend gains for the greenback.

Cable has been bouncing off 1.33, a level not seen since last November. The deteriorating political situation in Europe could ensure the Pound still has some allure, but with ongoing Brexit uncertainty and a lack of clarity as to whether we’ll see that Bank of England rate hike in August, the pair may struggle to rally.

The pair has now lost around 6.5% from the mid-April highs and the next level to watch on the downside is a return to the November 2017 lows around 1.1550. It’s worth noting that there’s an awful lot of bad news priced into the common currency right now, so just some clarity could initiate a meaningful rebound.

Despite the abundance of troubling news out of the Eurozone, gains for Sterling over the common currency remain relatively limited. There is an appreciating trend being seen for the pair here, but it’s a painfully drawn out process. Further political issues in the Eurozone may however provide the catalyst for a return to the April highs of 1.16.