Summary
A less alarmed reading of Italian politics and possible room for negotiation around U.S. tariffs hoists the market’s mood ahead of all-important payrolls data.
Italian curve yields
The last shoe to drop as sentiment recovered this week was a more definitive signal from the source of the initial mayhem: the short end of the Italian yield curve. It has now duly complied. The two-year BTP yield raced 52.8 basis points lower at one point on Friday morning and was last at 0.714%, below Thursday’s close and over 2000 basis points from fever-pitch levels. Benchmark BTP yields have also eased sharply, as have Italian shares. The FTSE MIB index was up 2.5% and up about 5% from mid-week lows.
EU affairs face Paolo Savona
Scope for Italian markets to go awry and stoke another round of global volatility has not entirely evaporated. True, Paolo Savona, the Eurosceptic former candidate for economy minister who triggered a mini sovereign debt crisis, has been side-lined in the revamped 5-Star/League coalition to the anodyne position of EU Affairs. But a populist economic platform and a new economy minister designate, professor Giovanni Tria, critical of EU economic governance, could mean the new government is still tempted to take chances with Italy’s dicey fiscal situation. Nor has Northern League leader Matteo Salvini rescinded pledges to re-examine the country’s euro membership when possible. Markets have signalled expectation that more measured politics to prevail, but risk premiums will keep some reserve in the uncertain near term. The government is to be sworn in on Friday afternoon. Moody’s has not lifted its threat to downgrade.
Tariffs plus negotiations
U.S. stock indices were 0.4%-0.5% aloft a piece, rebounding from the night before after the White House’s decision not to extend steel and aluminium tariff waivers took investors by surprise. A similar comeback in Asia leaving MSCI APAC in the black and Nikkei off lows was hinged on the wide-open door for further negotiation left open by Commerce Secretary Wilbur Ross: "Retaliations won’t mean there can't be more negotiations”. Retaliations are in. Canada, Mexico imposed new duties on U.S. imports including whiskey and pork legs. The EU says its own are ready to go. Presumably the trigger hasn’t been pulled due to expectation of more jaw-jaw vs. war-war. Indeed, with the new U.S. import regime coming days before a planned meeting between Ross and senior Chinese counterparts, it’s possible to read the move as extra leverage in negotiating tactics hinging on deterrence. For investors the global trade outlook remains fluid overall, until proven otherwise, hence a step up from outright bearish.
IBEX-35 welcomes socialist PM
Spain’s main index was near session highs at the time of writing after the leader of the Spanish Socialist Workers Party became PM. Pedro Sanchez promised to continue the fiscal programme of his predecessor Mariano Rajoy whose loss of a confidence motion triggered the smoothest swing to left-wing leadership from the right Europe has seen for some time. Sanchez was backed by six parties to secure the 180 votes to carry the motion. Most parties favour respecting fiscal rules. Furthermore, Sanchez’s pledge of ‘dialogue’ over Catalonia was also seen as moderate. Early elections are quite possible but the current balance of power in Spain is market friendly.
Yen retreats amid ‘risk on’
Risk barometers reflected the latest swing to ‘risk on’, including the yen. After threatening to extend its up leg from around a week ago, Japan’s currency was almost 40 pips lower vs. dollar at 109.20. The pair has struggled after recent U.S. payrolls though, meaning a good chance the dollar’s bounce could be used as a USD/JPY selling-opportunity after Friday’s release. Sterling also caught a risk-seeking bid against the yen, up almost 100 pips and challenging the risk-off yen low of 145.71 last Tuesday. But against the dollar the pound failed to win much traction in the bid to escape 6-month lows after factory PMI data were judged to be too ambivalent. Thursday’s sub-$1.33 closure leaves bears in control for now. The euro has fared better this week near its own 6-month lows and is set to post the first rising week in seven. It was challenging $1.1716 for the fifth time in about a week. The barrier must fall quickly for an extension of the week’s rise.
All eyes on average U.S. earnings growth
U.S. job figures are the obvious remaining focus. 188,000-190,000 is the headline expectation, though it’s been some months since the headline expectation has been the key watchpoint. In fact, the Federal Reserve will almost inevitably be agnostic to today’s NFP release, absent one of the most awful reports seen in decades, perhaps. So even a big miss on the average hourly wages front, the number most investors will be watching, will not deter the 25-basis point rate hike that looks baked in by Fed fund futures implied probabilities. The dollar would still lose its footing again in that scenario though, because it would tend to put discussion of a fourth rate rise this year – one more than Fed forecasts imply – to sleep for good. 2.7% growth in average hourly earnings in May, after a 2.6% print in April and a recent high outcome of 2.8%. The jobless rate is expected to remain lodged at 3.9%, implying more than full employment, according the Fed’s preference for 4.5%.
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