Italian Drama Weighs on the Euro

  • The dollar has posted divergent performances vs. the majors and EM this week
  • Italy Finance Minister Tria finally released his 2019 budget and it wasn’t pretty
  • Eurozone reported preliminary September CPI data
  • Japan reported September Tokyo CPI, August retail sales, IP, and labor market data overnight
  • During the North American session, the US reports August personal income and spending
  • Colombia central bank is expected to keep rates steady at 4.25%

The dollar is mostly firmer against the majors as Italy concerns rise.  Swissie and Loonie are outperforming, while the euro and Stockie are underperforming.  EM currencies are mostly softer.  PHP and KRW are outperforming, while HUF and ZAR are underperforming.  MSCI Asia Pacific was up 0.3%, with the Nikkei rising 1.4%.  MSCI EM is down 0.4% so far today, with the Shanghai Composite rising 1.1%.  Euro Stoxx 600 is down 0.4% near midday, while US futures are pointing to a higher open.  The 10-year US yield is down 2 bp at 3.03%.  Commodity prices are narrowly mixed, with Brent oil up 0.5%, copper down 0.1%, and gold up 0.1%.

The dollar has posted divergent performances vs. the majors and EM this week.  The greenback is up against every major currency this week but is putting in a mixed performance against EM.  If you’re wondering whether EM will eventually follow DM or vice versa, we think it’s the former.  We remain perplexed by this recent EM strength, especially given signs that US-China trade tensions likely to persist and/or worsen.  This divergence is unlikely to last and after FOMC, we remain bullish on USD.

The euro continues to trade heavy after failing to make a clean break above $1.18.  Developments in Italy are a clear negative, while the technical tone remains weak.  The single currency is trading at its lowest level since September 12.  The break of $1.1635 sets up a test of the September low near $1.1525.  Looking ahead, a break of $1.15 is needed to set up a test of the August low near $1.13.

Late last night, Italy Finance Minister Tria finally released his 2019 budget and it wasn’t pretty.  The projected deficit of -2.4% of GDP was higher than what Tria wanted but exactly what the ruling coalition wanted, and that’s not a good sign going forward.  Italian assets tumbled, with the 2- and 10-year spreads to Germany widening 48 and 43 bp, respectively.  We suspect Tria’s capitulation will lead the rating agencies to downgrade Italy in the coming weeks.

Eurozone reported preliminary September CPI data.  Despite the higher than expected German reading, headline CPI matched the consensus 2.1% y/y.  In fact, core inflation was 0.9% y/y vs. 1.1% expected.  Data is unlikely to have any impact on the ECB’s forward guidance.

UK reported Q2 GDP revisions and current account data.  The deficit was -GBP20.3 bln, slightly larger than expected.  Growth was cut slightly to 1.2% y/y from 1.3% previously.  The culprit was business investment, which was revised to -0.2% y/y from +0.8% previously.  This is the first contraction since Q4 2016.  Economists have long been warning about how the Brexit uncertainty would curtail investment, so we need to monitor this closely.  Wider external deficits and slower growth is not a good combination.

Japan reported September Tokyo CPI, August retail sales, IP, and labor market data overnight.  Headline CPI rose 1.3% y/y, while ex-fresh food rose 1.0% y/y, both higher than expected.  Retails sales rose a stronger than expected 0.9% m/m, but IP rose a weaker than expected 0.7% m/m.  Overall, the data are unlikely to have any near-term policy implications, as the BOJ just met last week and left all policies unchanged.

USD/JPY is moving higher despite posting an outside down day Wednesday.  Indeed, it seems that we had a double reverse as the pair recorded an outside up day yesterday.  The pair broke cleanly above the 113 level and is trading at the highest level since December.   Initial target is the December high near 113.75 followed by the October high near 114.75.

During the North American session, the US reports August personal income and spending.  The most important aspect of that report will be the core PCE deflator.  It is expected to remain steady at 2.0% y/y.  September Chicago PMI will also be reported, along with final September Michigan consumer sentiment.

Note that the Atlanta Fed’s GDPNow forecast for Q3 GDP growth was revised down yesterday to 3.8% SAAR from 4.4% previously.  This was due largely to the wider than expected advance August trade report.  Revised Q2 GDP growth reported by the Bureau of Economic Analysis was unchanged at 4.2% SAAR.

Colombia central bank is expected to keep rates steady at 4.25%.  CPI rose 3.1% y/y in August, above the 3% target but within the 2-4% target range.  The economy is gaining momentum, and so the central bank will remain in cautious wait-and-see mode for now.  Consensus sees the first rate hike coming in Q1, which seems reasonable to us.