Lacking Coherence

The nation that’s shaped like a boot
Is causing some problems acute
Their fiscal adherence
Is lacking coherence
And frankly it does not compute

Once again the euro is under pressure this morning, although it has recently rebounded from its worst levels of the day, as the Italian political saga has taken another lurch forward. It appears that the anti-establishment coalition of Five Star and the League have agreed on a neutral party to be prime minister, Giuseppe Conte, a law professor from Florence University with no previous political experience. And while it is bad enough that the third largest economy in Europe is going to be led by a political neophyte, I think of much greater concern is the story about Italy issuing BOT’s as a means of financing the new government’s spending plans.

While there is not much information on this yet, these BOT’s are seen as potentially quite destabilizing to the euro with the possibility that they become a parallel currency in Italy. The last thing that the euro needs is another structural question. I assure you that Signor Draghi has not forgotten just how close the euro came to breaking up back in 2012 amid the Euro government bond crisis (remember “whatever it takes”?). Unfortunately for him, his home country has never been able to regain the ground it lost during that crisis and the economy there remains more than 5% smaller than it was prior to the crisis unfolding. Issuance of this new paper will be strongly opposed by virtually all the members of the Eurozone, but at this stage, it seems unlikely that the new Italian government will care. After all, their hallmark is that they are anti-establishment! While nothing has been agreed at this stage, and it may simply be another trial balloon similar to the story about the ECB writing off €250billion that circulated at the beginning of last week, the fact that it is even under consideration is testimony to just how difficult things are in Italy, and just how difficult it will be to bring that nation back into the Eurozone fiscal fold. While this process continues to unfold, I believe the euro will remain under significant pressure. Hedgers, keep that in mind.

While that was a new twist in the Italian story, the reality is that there has been very little else in the market narrative that is new. Trade talks between the US and China were inconclusive when they ended on Friday, but Secretary Mnuchin’s comment that ‘the trade war is on hold for now’ seems to have allayed fears within the equity investor community as stock markets around the world have rallied modestly.

Otherwise, there has been virtually no data of note released anywhere in the world. This morning’s pattern shows that the idiosyncratic stories from the EMG space, (Turkey, Argentina, Malaysia, Hong Kong, Brazil) have all continued along their previously determined paths. Perhaps the biggest news is that the IMF and Argentina have finally sat down to begin to negotiate the stand-by loan that the country desperately needs. But otherwise, today’s price action is simply an extension of what we have been seeing for the past several weeks.

Looking ahead to the rest of this week, data is sparse with Wednesday’s FOMC Minutes the clear highlight.

Wednesday New Home Sales 677K
  FOMC Minutes  
Thursday Initial Claims 220K
  Existing Home Sales 5.60M
Friday Durable Goods Orders -1.3%
  -ex transport +0.6%

And that’s all on the data front. We do, however, hear from seven Fed speakers in a total of ten speeches with Friday’s comments from Chairman Powell likely to be the ones that everybody watches most closely. Of course, remember that Friday is the day before the Memorial Day holiday weekend here in the US, and so trading desks are likely to be lightly staffed then. That just means that if he were to say anything surprising (which I doubt) there would be the opportunity for more movement than usual given the likely reduced amount of liquidity that will be available.

All told, while things appear quiet for now, it is critical to remember that there are several important stories that continue in the background and that market liquidity is going to diminish as we hit the summer vacation season. That means that volatility is likely to resume its uptrend, especially if any one of these background stories comes to the fore. Nothing has occurred to change my view that the dollar has further to rally vs. all its counterparts, and until we see weak US data or a distinct change in tone from the Fed, things are likely to remain that way.

Good luck