Italian budget showdown nearing its climax

Italian BTP yields are at fresh highs as the European Union takes a tough stance on Italy’s bid to widen its fiscal deficit. Something will have to give soon and we are likely to see significant two-way action in the euro on coming headlines – so buckle up, euro traders.

The general message from EU representatives like Economic Commissioner Moscovici is that the budget rules must be obeyed. Others like Juncker have also chimed in while Italy’s Di Maio and Salvini have nothing to lose in completely refusing to budge, with Di Maio calling the EU agencies behaviour a kind of terrorism. 

The populists feel they are unlikely to be harmed by a further impasse, which could lead to new Italian elections and who knows, a call to finance some of the government’s desired programmes with a parallel currency? Does the EU really want to take the situation this far and risk a new government in Italy with a strong Lega component and an even more emboldened Salvini? Apparently, the EU game plan is to hope that the bond market will cow the Italian populists as BTP yields spike out of control and the Italian public loses confidence in FSM and Lega. It’s a risky gambit. 

The longer term inevitable answer to all the situation in Europe will have to be a fiscal expansion across Europe if the EU is to stay together as a functioning entity and keep the populists at bay. But do we have a crazy, one-off spike in Italian yields and other mayhem first? Regardless, the EURUSD sell-off could have a fairly short date to expiry… we are rapidly nearing the climax of this situation and we see very high potential two-way risk in the nearest term as the headlines roll in.

Wherever EURUSD bottoms out, the bounce will inevitably prove a hard one if fiscal rides to the rescue. 

The Tory party conference will wind down tomorrow, with Brexit hardliner Boris Johnson set to deliver a speech today to the conference and many wondering if BoJo is ready to finally challenge May for party leadership rather than criticising and clowning around at the margins. Sterling doesn’t seem to view the conference with much trepidation as a dysfunctional and divided Conservative party means lower odds of a hard Brexit and higher odds of a negotiation period extension and eventual second referendum. There are some risky assumptions in the mix, and we prefer to steer clear of drawing any conclusions on sterling.

Chart: USDCAD

CAD crosses have seen the most volatility over the last couple of sessions on the relief rally in CAD on the signing of the “USMCA” trade deal. As well, a bit of pent-up demand for CAD might have been building as crude oil prices have ripped higher, even if many Canadian crude grades are sold at steep discounts due to delivery problems into a locally saturated market. The USD looks rather firm at the moment, so CADJPY, EURCAD, and NZDCAD could prove more interesting, but we have certainly seen a big break here that could eventually lead to 1.2500 here as long as we remain below 1.2900.