02 Oct 2018: Another Fine Mess

Another Fine Mess

October 2nd: Highlights

  • Sterling likely to test 1.3000 while subject to every comment
  • Italian Budget keeps Eur under pressure
  • Dollar higher as U.S/Mexico/Canada Trade Deal close

An Irish Compromise on the cards?

There are unconfirmed reports (aren’t there always?) that the UK is about to offer a compromise to the EU to clear the logjam that exists around the issue of the Irish Border.

It is easy to be cynical about these announcements since there has been a plethora since Brexit began. It seems odd that the UK could be on the verge of a breakthrough given the comments made by Theresa May, Dominic Raab, and Philip Hammond over the past 36+ hours. Each in their own way has indicated that it is Brussels that will need to bend a little and that is almost certain to involve flexibility over the single market despite various pledges about the UK never being part of it, post-Brexit.

It is a difficult time to be trying to hedge a Sterling position as dollar buyers that are thinking 1.3150 is a decent level, can suddenly see 1.3250. The opposite is true for dollar sellers although each day the passes, downside pressure increases.

The pound had a turbulent day yesterday trading between 1.3116 and 1.3012. In the end, it closed virtually unchanged, just three pips below its open, at 1.3039. It fared a little better against the single currency (see below) trading up to 1.1282 and closing at 1.1264.

As the clock ticks down, there is a lot more hope than expectation over Brexit. Any compromise will need to be a game-changer to ensure that the idea that nothing is agreed until everything as agreed is complied with.

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Italian Budget drags Euro lower

The Nationalist/Populist Government in Rome has decided that it must comply with the promises it made to its people when winning the election rather than the limits agreed by the previous Government.

While keeping election promises is something of a novelty in politics, it seems that in this case, any rejoicing will remain firmly within Italian borders.

The reaction of the other Eurozone members to Italy’s budget, which will reach 2.4% of GDP over three years, has been uniformly hostile. The pledge of the previous Government was to maintain a budget at 1.6% of GDP.

There are fears that Italy is going down the same road as Greece and is almost setting its sights on a conflict with Brussels. It is odd that the Eurogroup expected any different outcome given the strength of feeling that swept the alliance between Five Star and The Northern Alliance to power. The Financial Affairs Commissioner (they have a commissioner for everything) commented yesterday that he didn’t see that the budget could possibly comply with the rules of the group. It is beginning to become abundantly clear that that was the point.

The Italian debt to GDP ratio currently stands at 130% of GBP while the ECB guideline is set at 60%, so it seems that that horse has bolted. To do what is suggested in its budget, that ratio, already the second highest after Greece, is going to rise close to 150% or even higher.

The euro continued to fall yesterday, reaching a low of 1.1563 and closing at 1.1578. It is hard to see what can be done by Brussels to haul Italy in, but its Economy Minister may have a few crumbs of comfort having pleaded with Brussels to “keep calm and await his explanation”.

Giovanni Tria is not a politician but an economist. Since he doesn’t have to be re-elected he may try to pour oil on the stormy waters.

Dollar rally not just versus weakening euro

The current weakness of the single currency has given a boost to the dollar but following last week’s rate hike by the Fed, the market is feeling very positive about the greenback right now.

While the spat with China is still very much alive, President Trump has managed to pull one rabbit from the hat by forging NAFTA II or The United States/Mexico/Canada Agreement (USMCA) to give it it’s full title. In this agreement, it appears Trump has gone some way to fulfilling his desires; Canada has weakened the protection of its dairy industry and levies on vehicles manufactured in Mexico will stop cheap imports of foreign manufacturers vehicles into the U.S.

The dollar index has been on the front foot since last Wednesday’s announcement and traders are now expectant that wage inflation will reach 3% when the employment report is released on Friday.

The trade spat with China rumbles on although it may be some time until there is another flare up since it appears the U.S. is awaiting the result of the tariffs already introduced, but with the trade deficit reaching $75 billion last month, there is still a long way to go.

China for its part has said this week that it will not negotiate with a knife held to its throat.

The dollar index reached a high of 95.37, the same level as the day before, so it may just be running out of momentum and will need a strong report on Friday to renew the market’s enthusiasm.

Have a great day!

About Alan Hill

Alan has been involved in the FX market for more than 25 years and brings a wealth of experience to his content. His knowledge has been gained while trading through some of the most volatile periods of recent history. His commentary relies on an understanding of past events and how they will affect future market performance.”