Euro finds its footing after Italian tensions ease, emerging market sell-off continues

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4 June 2018

thomasdodds

In spite of the jump in FX volatility, G10 currencies ended the week not far from where they had started it. Once again, political headlines from Italy were the main focus, and the positive news from both the Eurozone and the US were largely ignored by traders.

I
taly looks likely to avoid snap elections after the formation of a populist Government that appears to renounce an exit from the Euro, which Italians reject by a margin of two to one. These news allowed Italian sovereign bonds to recover about half of the ground lost since the crisis erupted, and the Euro managed a modest rebound against the dollar. All other European currencies followed in its wake, save the Swedish krona.

This week’s data is fairly light and we expect trading in currencies to be driven by political news out of Italy. In the short term, the absence of dramatic headlines could buoy the Euro, particularly after last week’s relatively good news in inflation.

Major currencies in detail

GBP

With no first tier data releases, and absent news on Brexit negotiations, Sterling largely followed the Euro gyrations in response to the news from Italian politics and sovereign debt markets. This week should be little different, though the PMI indices of business activity (Tuesday) will provide an early read on second-quarter growth performance.

EUR

Both the Italian and Spanish political crises appeared to be resolved, at least in the short term. In Italy, a right-wing populist Government was formed, but the controversial anti-euro economist Savona was given a junior position, while the key post of finance minister went to Tria. The latter was quoted in newswires as saying that “no political force” in Italy wants to exit the Euro. In Spain, Socialist Pedro Sanchez replaced the right-wing Mariano Rajoy as Prime Minister after a no confidence vote, though it is unclear how long elections can be delayed given the very weak Parliamentary support for the new Government.

Some good economic news out of the Eurozone flew under the radar last week. Core inflation for May rebounded strongly, albeit from a very depressed reading in April. We are keeping an eye on the key economic indicator which will drive the timing of any tightening of Eurozone monetary policy.

USD

The US payroll report for May provided a pleasant surprise across the board. In addition to surprisingly strong levels of job creation, unemployment ticked down, labour force participation went up, and wages also managed to surprise to the upside. It is surprising to see such strength in employment this late into the growth cycle. The news served to stop the budding Euro rally and take US 10-year Treasury rates above the 2.90 level, after their extraordinary fall from 3.12 to 2.76 in just two weeks of worrisome Italian news.