The Italian fiscal dispute with the European Commission could be viewed as a battle between orthodox EU rules and logical economic self-determination. The EU fears a lax stance on breach of the fiscal compact will open the door to all sorts of flagrant violations and so couches its argument in a single faulty metric, potential output gap. Italians for their part, make a more compelling argument based on firmer fundamental factors, like a high unemployment rate and low productivity, which make a strong case against impending inflationary pressures. Adam Tooze of Columbia University was quoted in the Financial Times as stating: ‘politics [is being] pursued by the technical means of economics,’ with the unintended effect of bolstering populist forces across Europe.’ Going on to say ‘It is a fine judgment what is the right thing [for Italy] to do, but what isn’t a fine judgment is that the European Commission shouldn’t publish nonsense,’ said Mr Tooze.
Bottom Line: Yet another financial risk is coming to a head. While it is unlikely to impact currency markets at the moment, we should be vigilant for sharp increases in Italian sovereign borrowing costs which would hit the common currency.
This week, investor flight to safe sovereign bonds in the US and Japan has pushed yields to 2017 lows on the 10 Year Treasury. This shift has also caused the trade-weighted Dollar Index to return to two-year highs – a level that has been tested three times already this quarter. The shift away from risk assets has been largely triggered by the ongoing lack of progress in the US-China trade war, as well as diminishing global growth prospects. As bond market flows push yields across the curve to alarming levels, the question is just how far will the current trend go? Overnight trading suggests increased appetite for risk, at least in the short-run, as emerging market equities in South America ticked higher while developed equities in North America fell. With a lack of development in the headlines driving the recent risk-off trend, a bigger push may be required to keep capital flow from returning risk assets.
Bottom Line: Risk-off trend shows signs of slowing as its key news drivers lack any real development.
Continued political uncertainty has led to a protracted pullback for the Pound Index to around four-month lows. The pair remains depressed at the bottom of its current trading range due to the safe-haven attractiveness of the Dollar, a push below would be met with little resistance.
The five-month descending trend channel looks to continue, with markets focusing on the US preliminary GDP release today. The Dollar has room to move higher as it targets index levels last seen in December 2018.
Thinner liquidity is expected for the Euro today as major countries observe Ascension Day. The pair is trading in a tight range around February’s lows with further consolidation expected as both the Pound and Euro sit at the bottom of their trade weighted ranges.