Italy Leaves Euro in A Lurch

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Market Drivers March 5, 2018
Italian stalemate puts EURUSD on a defensive
UK PMI Services beats
Nikkei -0.66% Dax 0.39%
Oil $61/bbl
Gold $1326/oz.
Bitcoin $11483

Europe and Asia:
EUR EZ PMI Composite 57.1 vs. 57.5
GBP UK PMI Services 54.5 vs. 53.3

North America:
USD ISM Non-Manufacturing 10:00

A pair of conflicting political results from Europe sent euro on a seesaw today as the currency oscillated between relief over political stability in Germany and concern over political chaos in Italy.

In Germany, Angela Merkel secured her fourth term as Chancellor after the SPD coalition voted overwhelmingly to accept the deal. The EURUSD popped to 1.2350 on the open only to lose all of its gains after the results of the Italian election trickled in. The Italian election turned out to be a mess offering no clear winner but sending a very clear message that the electorate was fed up with establishment politics. Center-left parties were the biggest losers, while the upstart 5 star party won a plurality of the vote but came up considerably short of any possibility of rule.

The Italian election is further complicated by the new voting system which uses proportional representation rather than winner take all approach. Experts expect at least several months of negotiations before any type of government may emerge. Beyond the usual byzantine politics of Italy, the markets may be concerned about the rise of 5 Star party which has emerged as a true force in this election. The 5 Star is a populist party whose platform does not neatly fit on the left-right spectrum, but more importantly, it is led by 31-year-old Luigi di Maio who has no prior political experience at all and almost no work experience as well.

The central question to the FX market is whether the populist revolt at the polls will ultimately lead to a referendum on membership in the EU. After a decade of stagnation, Italy has seen a strong return to growth, but the country’s remains hampered by the largest debt load in the EU and persistent productivity growth issues. For now, the markets are treating the election as a national event rather than an existential threat to the union with the assumption that after all is said and done Italian politics will return to business as usual. The EURUSD after taking a swoon in late Asia trade found support at the 1.2300 level and appears to have stabilized for now.

The political events in Europe have temporarily pushed US tariff concerns to the background but this week President Trump is expected to make good on his threat to impose tariffs on steel and aluminum which could the dollar under fresh selling pressure. On the calendar today the market will get a look at ISM Non-Manufacturing which along with its headline reading will provide the first glimpse into the employment report due at the end of the week. The market is anticipating a rise to 59.9 versus 59.0 which could provide some relief for USDJPY, but trading in the pair remains cautious around the 105.50 level and any negative surprise in data could easily send it to a test of lows at the 105.00 figure as the day proceeds.

Boris Schlossberg
Managing Director

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