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Italy and central banks to remain in focus

European shares managed to finish a choppy week on a fairly mixed note with the FTSE100 and German DAX managing to close above the 200-week MA, however the lack of sustainable rebound does raise the question as to whether we’ll be able to hold these key supports and potentially see further losses in the days and weeks ahead.

A big rally in Chinese markets has helped boost the Asia session after policymakers announced some temporary changes to tax laws at the weekend, however this is only expected to have a modest spill over to markets in Europe.

Increasing concerns about rising interest rates, trade, and geopolitics from Italy and now Saudi Arabia have served to keep investors a little cautious of loading up on significant amounts of fresh risk and the weekend decision by the US to pull out of INF, the Intermediate-Range Nuclear Forces treaty with Russia, over alleged non-compliance, is unlikely to improve the mood.

This week’s focus is likely to remain on Italy after ratings agency Moody’s downgraded the country’s credit rating on Friday to Baa3, one notch above “junk” citing stalled plans for economic and fiscal reforms, though they did change the outlook to “stable” which means another downgrade isn’t immediately imminent.

The knock-on effect of this will inevitably result in further pressure on Italy’s banks, already overburdened with non-performing loans, they could be faced with having to raise extra capital at a time when they will likely face further downgrades as well.

We did see a recovery in Italian bonds and stocks on Friday on comments from European Commission economic affairs commissioner Pierre Moscovici who said that Italy’s deficit of 2.4% wasn’t the main problem, and that it was more to do with measures to deal with the overall debt pile and measures to boost growth.

This more emollient tone was interpreted as a sign that the European Commission might be trying to adopt a more conciliatory approach in an effort to head off a confrontation which neither side can afford to get out of hand, particularly since there does appear to be some contagion creeping into Spanish and Portuguese bond yields, which also pushed higher last week.

As if to emphasise the reluctance of the Italian government to be too confrontational with the EU Italian deputy PM Salvini reiterated at the weekend that there were no plans for Italy to leave the EU or euro.  Putting all of that to one side Italian stocks still finished the week at 18-month lows and firmly in a bear market, while 10-year yields still closed near 3.5%, at four year highs, having hit 3.8% at one point during the day.

The Italian government is expected to give its response to the EU’s rejection of the budget later today, but has insisted they will not resile from their commitment to expand their budget deficit to 2.4% of GDP next year.

It’s also likely to be another week of ups and downs for the pound with respect to any Brexit talks, after last week’s failure to reach an agreement on the Irish border, while there are rising rumblings over the leadership of Prime Minister Theresa May with some suggestions that she might be on the verge of facing a leadership challenge, from disgruntled MP’s unhappy at her negotiating strategy with the EU.

On Wednesday there is a meeting of the Conservative party’s 1922 committee where this unhappiness could be given further oxygen with reports that as many as 46 Tory MP’s have written letters demanding the Prime Minister be replaced. That is two short of the 48 needed, however the question of who might replace her remains an open one as any new candidate will need the support of over 159 MP’s to win any final ballot. 

It’s also a big week for central banks with the latest decisions from the European Central Bank and Bank of Canada, with the most focus likely to be on ECB, given current tensions between Italy and the EU, as well as a weakening in the economic outlook, with this week’s latest flash PMI’s from France and Germany for October expected to continue to slip back.

We’ve also got US Q3 GDP on Friday which is likely to show the US economy still remains in fine fettle, albeit slower than Q2’s 4.2% expansion, while over the border in Canada, the Bank of Canada is expected to raise rates by 25 basis points.

EURUSD – finding some support at the 1.1430/40 area, which has prompted a rebound but we still need to get above the 1.1620 level where we struggled last week. A break below the 1.1430 area, opens up the 1.1300 August lows.

GBPUSD – continues to hold above support above the 50-day MA and trend line support from the 1.2660 lows at 1.3000. We need to see a move back above 1.3150 to stabilise and argue for a retest of this week’s peaks at 1.3240.

EURGBP – finding resistance at the 200-day MA at 0.8840 for now, and while below we could retest the October lows at 0.8720. Above 0.8840 targets the 0.8890 level.

USDJPY – having found support at the 111.60 trend line support from the March lows the US dollar has struggled to move beyond the 112.80 level. We need to hold above 111.60 to keep the uptrend intact and move back towards the previous highs at 114.60. A break below 111.50 suggests the prospect of further losses towards 111.20, and even the 200-day MA at 110.35.

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