Daily Market Brief 29 May 2018

Italian Crisis deepens

May 29th: Highlights

  • Election to be quasi EU referendum
  • Sterling falls as BoE and Treasury disagree over regulation post-Brexit
  • Dollar turns reactive

Italian President nominates “stop-gap” PM

The crisis in Italian politics deepened yesterday as the President stood by his decision to not approve the coalition’s choice for Finance Minister and nominated a former IMF economist as interim Prime Minister.

Carlo Cottarelli is known as “Mr Scissors” for his cuts to public services. He has been nominated by a President who was himself nominated by a Government that lost the election and whose policies, particularly towards public services and Europe inflamed the electorate and the led the upsurge in populism.

The new elections which could be held as early as August, although given the Italians tend to mostly be “on vacation” are more likely to be held in September at the earliest, will now be a referendum on Italy’s continued role in the European Union and Eurozone.

The single currency broke the 1.1680 support emphatically and fell to a low of 1.1606. It has stabilized overnight without correcting at all.

The gap between the yield on Italian and German Government bonds has widened to its highest since 2013 reflecting both the markets concerns over Italy’s future and a flight to quality. The euro’s fall is likely to continue with little positive to provide impetus for a correction.

It is now likely to be a long summer for the single currency, with further falls raising concerns over their inflationary effect despite the two-speed nature of the Eurozone meaning that the weaker economies will see better growth driven by an ability to export more.

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Bank of England becoming more involved in Brexit

A spat between the Bank of England and the Treasury over the regulation of financial markets post-Brexit has highlighted the greater role that the Bank is taking in the UK’s departure from the EU, “behind the scenes”.

Although the “headline” issue is regulation, the responsibility of Deputy Governor Jon Cunliffe, the Banks’ wider concerns over contingency plans for a “no-deal” Brexit, which have, to all intents and purposes ground to a halt, are what is at the core of the dispute.

This appears to be another example of the muddled thinking of a Government lacking the confidence to be bold in its thinking and continuing to plan more in hope than expectation they will get it right.

The headwinds that have beset the pound in recent weeks and have driven it to a low of 1.3295 and 1.1307 will pale into insignificance if the proposals due in the next few weeks don’t deliver on established promises.

The fact that one of the most crucial issues from “stage one” still has no workable solution is a major concern to both Brussels and the financial markets. The Irish border remains the “damned if she does and damned if she doesn’t” scenario that will be eagerly awaited when the plans are released. Sterling continued its fall yesterday and closed at 1.3310. It is managing to perform a little better versus the euro but that is due to the political issues facing the single currency.

Dollar gains “by default”

The start of the recent fall in the euro which has gathered pace and a “life of its own” was started by a rally in the dollar index and the euro fell “by default”. Tables have now been turned and the euro has become the prime driver of the continued rise in the index.

It has been obvious that the gloss was beginning to fade of the index’s rally as first President Trump’s foreign policy initiatives started to become less than well received, monetary policy became reactive again and the yield on long term debt appeared to have topped out.

Now the dollar has become reactive to the fall in the euro, which has “legs”, and is unlikely to stop until a solution is found to Italy’s political woes.

This week’s employment report will bring the usual frantic activity over the headline, which unsurprisingly is expected to be +185k by analysts who have given up even trying to be imaginative over data which this month will be even more of a guess (sorry, estimate) than normal as it will be released, unusually, on the first day of the new month.

A little more consideration goes into the analysts’ expectations for wage growth and that is expected to rise from last month’s 2.6% to 2.7% which will alert the FOMC but will do little more and a June hike remains “in the balance”.

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.”