Euro Weakens as Italy Crisis Deepens
- Further weakness in euro on Friday sees it approaching YTD lows as the Italy budget crisis deepens ahead of Tuesday’s deadline for Italy to resubmit its budget proposal to the European Commission (EC). Market pessimism deepens as Italian finance minister Tria strikes a defiant tone in his meeting with euro group President Mario Centeno. Citi analysts do not expect the Italian government to compromise and note the EC has no legal means to force capitulation of Italy’s populist government. Its only recourse appears to be to open up an Excessive Deficit Procedure (EDP) by November end which threatens fines and which risks a strong backlash from Italy.
- The EC’s forecasts on Italy project a budget deficit above 3% of GDP in 2020 on expectations Italy’s GDP will grow just 1.2% in 2019 (in contrast to the Italian government's own forecast of 1.5%). But the lower EC growth forecasts are the very reason why Italy wants a solid expansionary budget. Citi analysts are even more pessimistic on Italian growth and raise the probability of a recession amid higher interest rate spreads and lower business confidence and therefore, do not expect the Italian government to compromise when Italy resubmits its budget proposal to the EC this week.
USD: Gains vs G3 counterparts (EUR, JPY) driven by external drivers
- The USD rebound from the US midterms continues Friday as it approaches 2018 highs against EUR and JPY on the deepening Italian budget crisis and slower Chinese growth (both external to the US) and coming against the backdrop of rapidly approaching year-end. At the same time, other G10 currencies such as sterling and the commodity bloc remain relatively resilient.
- US 2nd tier data on Friday sees the University of Michigan Sentiment index marginally higher at 98.3 versus 98.0 expected with 5-10Yr inflation expectations up marginally to 2.6% and headline US October PPI beating consensus at 0.6%MoM versus 0.2% expected. Neither of this alters the Fed rates outlook for a December hike and has little impact on FX sentiment.
- A key week for FX coming up that sees US-EU trade talks on Wednesday, the USITC report on the USMCA impact on Thursday and most importantly, Italy re-submitting its budget to the EC on Tuesday. Fed Governor Powell speaks Wednesday while US October CPI and retail sales are released later in the week (Citi expects core CPI up 0.2%MM, headline retail sales up 0.4%).
Commodity bloc: RBA modestly revises up growth, CPI forecasts
- The RBA board does not see strong case for near-term change in cash rate but raises its outlook (albeit modestly) for inflation and unemployment, setting the stage for higher interest rates at some point. Australia’s GDP growth is forecast to be above trend at 3.5% for 2018, 3.25% for 2019 and 3.25% for 2020 while inflation forecasts are also revised up slightly - 1.75% December 2018, 2% June 2019, and 2.25% from December 2019 to Dec 2020.
- The recent thawing in US – China tensions sees commodity bloc outperformance vs USD, EUR and JPY with NZD and possibly CAD better placed than AUD in any follow through rally given prospects for RBA to delay its rate hikes to late next year. Citi analysts now see the RBNZ pulling the trigger ahead of the RBA (Q3’19 vs Q4’19) while BoC is expected to hike 3 more times next year.
This is an extract from the Daily Currency Update, dated 12th November 2018. Please approach a Citigold Relationship Manager if you would like more information