Italy Defiant – EURUSD Tumbles

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Market Drivers October 2, 2018
Italy defiant – EURUSD tumbles
UK PMI Construction
Nikkei 0.10% Dax -0.46%
Oil $75/bbl
Gold $1193/oz.
Bitcoin $6600

Europe and Asia:
AUD RBA leaves rates 1.50%
GBP UK PMI 52.1 vs. 52.5

North America:
No Data

Italy remained defiant in its attempt to expand its budget deficit beyond the 2.0% level, ignoring EU’s rejection of the plan and risking a downgrade by the rating agencies.

The spread between Italian and German bonds has reached five-year highs as the new populist Italian government remained adamant about expanding fiscal policy in order to jump-start Italy’s moribund economy. Italian interior minister Matteo Salvini stated that he “doesn’t care if EU rejects his budget.” Adding, “No one in Brussels can tell me it is not time.”

The defiant mood of the Italian lawmakers has sent chills through the FX market as fears of another sovereign debt crisis began to swirl around the EURUSD. Italy is a far bigger problem for EU than Greece ever was. It’s 1 Trillion-plus economy with the largest debt to GDP ratio amongst the major OECD nations. Any deterioration of its fiscal position could usher in a buyer strike for its sovereign debt, which in turn could destroy the balance sheets of its banking sector. The problem goes even further, as French banks are reported to have more than $300 Billion in exposure to the country’s debt.

The sudden confrontation between Rome and Brussels, though eminently predictable ever since the election of the new populist government can now pose a serious problem for ECB. The central bank remains adamant on tapering its QE policy by end of this year. However, as the only true backstop in this brewing crisis, the ECB may be pulled back into the fray and might even consider resuming the QE in order to dampen the spike in Italian yields.

In the end both Brussels and Rome understand that an outright confrontation on this issue is a disaster and may yet reach a compromise agreement before the budget deadline. For Brussels the issue of EU unity is paramount. For Rome ironically enough the insistence on a higher fiscal deficit could actually slow down growth in the region as it will make credit much more expensive and will further deteriorate the balance sheets of Italian banks.

For now, however, the markets are in full risk-off mode and until they see some conciliatory noises from politicians EURUSD could test the 1.1500 level by days end, while GBPUSD drifts towards 1.2900 and AUDUSD moves towards .7250

Boris Schlossberg
Managing Director

One thought on “Italy Defiant – EURUSD Tumbles”

  1. Dear Mr Schlosdberg, as I have commented several times furing the past months tje ECB is cornered by its own QE. The QE was intended to stimulate the consumption and incestments, however it never left the banks to the consumers. Instead the EU banks transferred huge amounts of free-money to their Branches in US and deposited the money with a nice risk-free profit att the FEDs excess reserve account.
    Now ECB owns on average some 60.% of all Eurozone government debt. Of course ECB owns much higher rate of the Sovereign debts in Southern Europe such as in Portugal, Italy, Greece and Spain (so called PIGS). ECB even bought huge amounts of private junk bonds. Draghi destroyed the bond markets. Look on the spreads between the US Treasury. bonds and the European bonds. It will be No Bid if ECB taper, with interest costs killing the state budgets of primarily Southern Europe. It will go very quickly up to double digits bond yirlds if any tapering by ECB, not slowly nor gradually.
    What must not be forgotten here is that systemic banks like BNP Paribas and Societe General are at risk, but so is also Deutsche Bank and Commerzbank along with all Spanish and Italian banks. There is no possible bail-in this tlme around, the problems are too big and the states/ECBs gun powder cags are either wet or emptied after 10 years of failed QE. No inflation, no real growth, no reforms, no productivity increase, but instead just more speculative asset bubbles.
    To justify or explain the problem in Italy pleaee look on the high unemployment rates of young persons and the spiking age for the first homeowners and getting married. The risk is much higher than just the credit markets, this may well lead to serious civil unrest. The iincreased mmigration flows since 2015 is not a good combination with a brewing Sovereign Debt crisis.
    But another big elephant in the room which nobody addresses in media are the unfunded pension funds throughout Europe. Look on Spain or Germany for instance. They all needed some 8% yield but had near to zero for past 10 years with some 60-100% having to be allocated to national “safe” bonds. Some have walked out to riskier assets such as corporate junk bonds or EM bonds with currency risks biting their tails.
    The majority is always wrong, Bloomberg wrote a piece the other month that Dollar bulls were extinct…
    US federal debt is a high number above 20 trillion USD and Trump is a recköess twitter user without normal manners. But the global debts are above 200 trillion USD and the political chaos in EU is 100 worse than Trump’s tweets. The Middle East is waging war involving Russia. China and Asia are having debt problems with USD debt when rates increase and USD rallies. So US looks like the safe place relatively to all others.
    Capital Flow analysis is everything now, not NPL och PMI figures etc. Shillers P/E spiked 2008-2009 when market crashed, capital ran to stocks as safe haven. It is happening now with DOW and USD. Gold and Commodities will be later. Bonds will crash hard with historic low interest rates.

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