It’s a damning indictment of what low regard politicians are held in when for the second time in a week we’ve seen markets rally on the resignation of a prime minister (first Greece, now Italy). And not just domestic markets; even US stocks squeezed out a 0.5% rally on the news. From here, it’s a question of whether a change of captain can steer the ship away from the rocks, or whether the vessel remains doomed.
For sure, the Berlusconi administration was often steering the wrong course, with the captain in the cabin rather than on the bridge, but the numbers remain the same. Italian yields are pushing 7% on the 10yr bond, growth has been anaemic for years (averaging 0.7% since start of EMU) and debt remains 120% of GDP. Furthermore, the lifeboat (the EFSF) is insufficient to perform a successful rescue. We remain in very testing times, but the euro itself also remains relatively resilient. The impact on Italian bonds is being overshadowed by the increase in margins from one of the main clearers, which makes it even more costly to hold Italian debt.
Guest post by FxPro
Commentary
China’s continued inflation moderation. CPI fell further from the 6.1% reading of Sep to 5.5% in Oct. This was broadly as anticipated, but nevertheless remains welcome as other data revealed a further moderation in the pace of industrial production (from 13.8% to 13.2% in Oct). It looks unlikely that China will cut interest rates before the year is out, not least because CPI will still be above the 4% target for this year. Nevertheless, there remains the possibility of more targeted measures to address the slowdown in the economy.
Sterling’s sweet spot. So far, sterling has been one of the main beneficiaries of the turmoil in the eurozone since the Greek referendum debacle started early last week. Only the yen has performed marginally better over this time and within Europe sterling has also benefitted from the pressure and nervousness surrounding the Swiss franc which has proven to be one of the weakest performers. The Scandinavian currencies have also struggled as liquidity becomes more of an issue towards year end. One of the reasons for sterling’s relatively decent performance has been the fiscal position of the UK compared with much of the eurozone. The UK started down the road of fiscal austerity some 18 months ago, so in some senses is further ahead than many other eurozone currencies, at least in terms of the change in fiscal dynamics rather than the absolute level of deficit. The issue now is how long this can last, because after the relatively punchy Q3 GDP outturn of 0.5%, the economy looks poised to slow in the fourth quarter (especially if recent PMI data are to be believed). Even though in line with expectations, the numbers show the average production change to have been flat both on the 3mth and longer 12mth views. So long as the focus remains on the fiscal side, sterling should (for the moment at least) be immune to the softening of the economy.
Euro bears are still plentiful. For some time now, the currency trade de jour has been to be short the single currency. Unsurprisingly, the overwhelming consensus amongst both traders and investors remains that the single currency is still deeply vulnerable. Traders are still very significantly underweight in the euro, according to the latest CFTC data. Foreign investors have been shedding their European bond and equity investments over recent months. Real money managers have substantially lowered their effective exposure to the single currency this year. US money market funds have chopped their exposure to European banks this year to such an extent that many of the latter are really struggling to access dollar liquidity. Even sovereign wealth funds have not been enamoured with the single currency over recent months, as confirmed by the IMF recently. And yet, despite all of these negative forces, despite all of this apparent selling pressure, despite the realistic threat that Italy may soon be in the hands of its creditors, the EUR is still trading at 1.38. To put this into perspective, the euro is only barely below the 12mth average of 1.3930. Clearly, notwithstanding understandable reservations over Europe’s deeply troubling sovereign debt and banking crisis, investors and traders still harbour huge concerns regarding the dollar as well. Committed euro bears ought to be worried.
Aussie out of favour. After last month’s dramatic recovery which saw the currency climb almost 15% from its lowest point, the Aussie has progressively lost traction and is now poised just above 1.03. In many respects, the softness experienced over the past week or so is not surprising against the backdrop of heightened nervousness regarding the situation in Europe and with the RBA lowering the official cash rate last week. Intriguingly, any risk aversion that has been evident this month has been very selective, in that only European and Japanese equities are down for the month-to-date, while commodity prices such as gold and oil are mostly higher. As such, it is of interest that the Aussie has underperformed. The recent news that the trade surplus narrowed in September hurt the currency, with traders troubled by signs of slowing exports. With the economy down under on a much lower trajectory this year, there is a growing likelihood that the central bank will be tempted to lower rates still further in coming months. For Aussie bulls, a regime of rate-cutting will probably be unhelpful.
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