EUR dips through support on PMI’s Italy stand-off

Headline exhaustion and further headline risk on Italy’s budget and Brexit may be making traders hesitant to commit to a position in the euro or sterling, respectively until we get more clarity in either direction, a prospect that feels weeks away at best. Also weighing on global markets is whether China will choose to abandon the CNY floor.

Italian BTPs are stuck in the middle of the local range after the EU yesterday asked Italy to resubmit its 2019 budget, an unprecedented stop. Italy’s Finance Minister Tria was out this morning making conciliatory noises, but the Lega’s Salvini and FSM’s Di Maio call all of the shots here and are not likely to back down one centimeter. Their confrontational stance on the budget has seen their aggregate popularity in the polls rise from just below the 50% level at the election to well north of 60% – mostly down to a doubling of the Lega’s popularity, while FSM has only faded slightly. A recent poll suggests that a majority of Italians now are in favour of leaving the EU, even if a stronger majority are in favour of keeping the euro. Could the populists begin to dangle an election to solidify their majority with the embedded promise of an “Italexit” referendum threat if the EU refuses to back down? 

EU existential risks remain front-burner through the weekend as the Hesse state election in Germany could prove a precursor to a Merkel exit at the CDU party powwow in December, as well as the risk that the collapsing SPD pulls out of the grand coalition to avoid further carnage and leaking of voters to the Greens and generally leaving Germany’s political scene adrift at least until the next election in 2021.

This morning’s Riksbank meeting disappointed with its cautious tone and the lack of a commitment to a move in December, as the “December of February” language was retained and the CPI forecasts for 2019 and 2020 were kept unchanged despite some recent hotter inflation data. For some reason, 2019 growth expectations were revised down to 1.9% from 2.0%. In short, this meeting has so far not pressed the hawkish buttons the market was looking for and EURSEK could get lost in limbo again above 9.30 unless Governor Ingves pulls something out of his hat at the press conference. 

In EM, watch USDBRL ahead of and after this weekend, which should see the right populist Bolsonaro, seen as a Trump-like figure (or Duterte-like), winning the second round vote. USDBRL is approaching the 200-day moving average and enthusiasm for BRL is rather remarkable given the wobbly global  backdrop and concerns on China, etc. Brazil is a major commodity exporter to China, with some 19% of its exports China-bound in 2016.  Brazil’s credit spreads have improved in line with the BRL rally, but a further strengthening will require a President Bolsonaro to discipline the fiscal outlays linked to Brazil’s overgenerous pension system.

Also on the EM agenda is South Africa and the 14.00 level in USDZAR as the market looks for signs that the South African government is showing the required fiscal prudence to continue to shore up the ZAR’s prospects when Finance Minister Mboweni unveils a mid-term budget policy statement this afternoon. 

Chart: EURJPY

EU existential risks and a new global risk-off move would likely favour EURJPY downside, a prospect we have visited many times before, but the two-way headline risk and recent rise in bond yields have kept the action very choppy. Still, as long as risk appetite remains nervous and the Italy budget stand-off continues – which we feel it will – the downside risk appears greater. The next area of interest lower ist he big 125.00 zone where the action was twice supported earlier this year.