It was a bad start to the week for markets in Europe and the US as stocks on both sides of the Atlantic fell sharply over concerns that political instability in Europe might cause financial dislocation to the banking system across the continent, as banking stocks got hammered, and investors piled into US treasuries, gold, and the safe havens of the Swiss franc and Japanese yen.
These concerns look set to continue this morning with another lower open as investors continue to eye the latest developments in Rome, as well as the prospect of elevated trade tensions after President Trump announced that the US would be proceeding with $50bn worth of tariffs on Chinese in imports. With EU exemptions on US tariffs also due to expire this Friday, markets are likely to find it difficult to catch a break today.
Only two weeks ago the FTSEMib was the best performing European stock market, up over 12% on the year. In that time, it has given up all those gains to be trading in negative territory, and down 3% on the year, as investors flee Italian assets over concerns about a possible Italian exit from the euro, while bond yields surged to their highest levels since 2012. This is only likely to be a concern if we remain at these levels, and it is important to note we still remain well below the levels we saw in 2011 when Italian yields were above 7%.
The time to worry is when and if yields return to these lofty heights, when ECB President Mario Draghi pledged to do “whatever it takes” to preserve the euro in 2012. This pledge marked a high water mark for Italian borrowing costs. It remains to be seen if he will be able to perform the same trick twice, with the hope that he won’t have to.
While these concerns are overstated at this point the complacency around Italian politics and its banks in the last twelve months has prompted a sharp unwind in investor exposure to Italy, something we were reminded of at the end of last year when it came to light US hedge fund investor Ray Dalio was betting big against Italian banks, a position he doubled down on in February this year.
At the time Intesa Sanpaolo CEO Carlo Messina warned that Dalio would lose money on the position, claiming that his bank was in a strong position. Given recent events those remarks haven’t dated particularly well.
Even so it is hard to escape the feeling that the losses of the past few days have been largely self-inflicted. If one were looking to create the conditions for a rout in Italian bond and stock markets then the events of the last few days were the perfect way to do it.
The Italian President Sergio Mattarella may well have been perfectly within his rights to veto the appointment of Paolo Savona as finance minister of a new populist Italian government but the way he went about it has been a gift to euro sceptics across Europe, let alone in Italy, fuelling a perception that the established order is subverting democracy.
The appointment of a technocrat Carlo Cottarelli a former IMF official is unlikely to gain the support of Italian politicians and as such it now seems likely that we will see new elections before the end of the summer. Against such a backdrop and a potentially politically toxic environment it is quite likely that whatever the outcome of any vote the damage to perceptions of democracy could be significant, especially if EU officials attempt to bully Italian voters into not voting for Five Star and the League, between now and a likely second vote.
In a sign that EU officials have learnt nothing from previous crises the selloff in Italian assets yesterday allegedly prompted comments by EU commissioner Gunther Oettinger that financial markets would bring Italian voters back into line and despite clarifications that his remarks were misreported the reports did not go down well.
This appears to be something politicians in general tend to be very good at it, opening their mouths before engaging brain. In the current environment, sometimes it is better to say nothing, than to say anything at all especially at times like this. Sadly, it is a lesson they seem incapable of learning.
Events in Spain are also making markets nervous after it was announced that Prime Minister Rajoy was likely to face a vote of no confidence on Friday which if he loses could bring about new elections.
The risks here are in no way of the same magnitude than events in Italy, however given the concerns around the Italian banking system, and a possible contagion effect due to rising bond yields.
Against this sort of backdrop, it is hard to envisage the ECB looking to signal a reversal of its currently easy monetary policy, when it meets next in June, even without recent concerns about below average inflation.
As far as economic data is concerned today’s main focus is expected to be on the US economy and the latest Q1 GDP number and ADP employment report for May. Both are expected to be supportive of a US rate rise next month, with a 2.3% expansion confirmed along with 190k new jobs added.
EURUSD – has continued to fall, pushing down to the 1.1500 area yesterday after last week’s move below the 1.1700 level. The 1.1500 level also corresponds to trend line support from the December 2016 lows at 1.0340. A move below 1.1500 could well open up a move towards1.1360.
GBPUSD – continues to drift lower as it heads towards 1.3110 trend line support from the January 2017 lows. Resistance now comes in at the 1.3360 area.
EURGBP – has remained under pressure with a break below 0.8690 potentially opening up a move the recent lows at 0.8640. Resistance remains back at the 100-day MA just below the 0.8800 level.
USDJPY – has continued to drift lower with potential to head towards the 107.40 area. We need to see a recovery back above the 109.80 level to stabilise.
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