Euro Dips as Italy’s Political Future Uncertain

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Market Drivers For Dec. 10, 2012
Monti announces resignation after budget passage, elections in February
Chinese Trade data misses badly
Nikkei 0.07% Europe -1.19%
Oil $86.27/bbl
Gold $1710/oz.

Europe and Asia:
CNY Trade Balance 19.6B vs. 26.7B
JPY Final GDP -0.9% vs. -0.8%
AUD Home Loans 0.1% vs. 3.1%
EUR Trade Balance 15.2B vs. 15.9B
EUR Sentix -16.8 vs. 16.2

North America:
CAD Housing Starts 8:15

The euro was under heavy pressure on the first trading day of the week in the wake of the announcement that the country’s technocratic Prime Minister Mario Monti would resign after the budget passes sending the country into a fresh set of elections as early as mid February. Mr. Monti has not yet announced if he would run, but early polling suggests that centre-left PD party led by Pier Luigi Bersani is holding a plurality lead of 38% as of now. The news sent Italian equities sharply lower, Italian bonds yields sharply higher and led to a gap down open for the EUR/USD as the pair traded to a low of 1.2885 before recovering slightly to retake the 1.2900 handle.

Many analysts have noted that the reaction in the markets may have been overdone given the fact that Mr. Monti would have have had to call for elections in a few months time anyway and that his decision simply expedites the process. Furthermore, Mr. Bresani has stated that he would continue Mr. Monti’s austerity policies to bring the budget back in line. In addition, Mr. Bresani if he were to be elected would bring an air of legitimacy to his post that an appointed Mr. Monti did not have. However, all those arguments miss the point that it was precisely because Mr. Monti’s government was not political in nature that it was able to provide a sorely needed sense of stability to Italian fiscal policy. Given the chaotic history of Italian politics, it is almost certain that whoever is elected Prime Minister will not be able to exercise anywhere near the level of control over the country’s fiscal policy enjoyed by Mr. Monti.

Little wonder then that the country’s capital markets remain in turmoil as investors try to process the latest news and keep an eye on Mr. Berlusconi who remains the wildcard in this scenario. Mr. Berlusconi is only polling 14% at the moment, but as several analysts pointed out his vast media holdings and well known marketing skills could quickly change that equation. If he begins to build momentum, the capital markets in Europe will only grow more volatile as the prospect of another Berlusconi government would wreak havoc in the EZ putting further pressure on the sovereign debt markets and the EUR/USD.

Meanwhile in China the trade data missed its mark badly printing at $19.63B surplus versus $26.85 expected as both imports and exports collapsed relative to expectations leading some investors to question the relatively robust Industrial Production and Retail Sales data issued on Saturday. Chinese exports rose only 2.9% versus 9.0% expected while imports were flat on the month versus forecasts of 2.0% gain.

Some analysts have suggested that the sharp falloff in exports may have been due to the strike at Los Angeles Long Beach port which handles much of the Asian trade into North America, as US importers front loaded demand into October in anticipation of the interruptions caused by labor unrest. However, Chinese exports were also sharply lower to Europe contracting -18.0% in November after falling -8.1% in October . That data suggests that global demand for Chinese goods may be slowing far more than the market expects putting in question the relatively strong Chinese Industrial Production results which showed a gain of 10.1% versus 9.8% anticipated.

If Chinese trade data does indeed reflect a much steeper decline in aggregate global demand, rather than just one off factors, then risk assets could see a sharper correction into the year end as investors make proper adjustments. So far the reaction in the currency market has been muted with AUDUSD losing only 20 points to remain well within striking distance of the 1.0500 barrier as it trades at 1.0475. However, as uncertainty grows both in Europe and North America, the anticipated growth scenarios for the world’s two biggest markets could quickly change and the pressure on risk assets is likely to resume if further evidence of slowing demand appears on the horizon.

Boris Schlossberg
Managing Director

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