Summary
Signs abound that key challenges to risk appetite have been sufficiently priced.
BTP yield relief
More emollient comments from Rome and Brussels set the tone for the week and Moody’s didn’t set the floor for Italian credit lower than the market had already assessed. (Downgrade, yes, negative outlook, no). Hence the FTSE MIB retains a good chunk of a near 390-point opening jump. Hefty drops by obsessively watched 10-Year BTP yield and its spread to benchmark borrowing costs stay dropped, for the most part.
The spread got below a psychological 300 basis points for only the second session this month. The yield got beneath the 3.4%-3.7% range for the first time in a fortnight. Both states were slightly reversing at last check though not in alarming fashion.
Outbreak of diplomacy
Exactly what happens next is the usual EU mix of formal and slightly obscure procedure and expediency. Despite the draft budget having been sent as per protocol last week, the government will forward a letter to the Commission on Monday afternoon. It’s not yet clear when the Commission might respond. But the desire for “a constructive dialogue” (Economic Commissioner Moscovici) and willingness to “sit at the table” and discuss (Deputy PM Di Maio) count as promising. Both sides stop short of open willingness to compromise, so the first ever Commission request for a budget revision is likely to come on Tuesday.
Continued stock and bond market stabilisation partly depend on how the request is worded and the ability of all sides to extend use of more conventional diplomatic language.
ECB set to wait
The single currency’s latest foray to the higher side of its roughly $1.14-$1.16 range since the end of September also needs the EU-Italy political temperature to keep easing. One further source of relative certainty is that a data-driven European Central Bank will almost certainly use softer than expected recent core inflation as a reason to ‘keep waiting’ at this week’s meeting rather than beginning to define reinvestment plans.
ECB intention regarding asset purchase proceeds is the market’s test of normalisation prospects, right now. Policymakers will no more be able to escape addressing Italy as the euro will escape volatility on Thursday, but the greater focus remains Italy.
Watch for ‘special’ summit
Sterling is the biggest loser amongst majors. The backstop theme remains a sell above high $1.3080 though there are clear limits after the fall below $1.308 on Thursday. With a deal ‘95% done’, according to what Prime Minister Theresa May will tell Parliament soon, room for compromise is restricted increasingly by domestic elements, but the mathematics of a leadership way out of the snag still don’t stack up.
A political crisis looks almost inevitable, though probably not before next March. Either way, sterling has priced an implosion in granular form by now yet has not sustainably traded below $1.30 in October.
Market attention is likely to switch to the chances of another Brexit summit being scheduled before the keynote one in December’s, after the ‘special’ pencilled in for November was cancelled last week. The EU27 “stands ready”. Tightly knit support bounded by $1.3028 and a strong rejection of $1.3009 on Friday will be watched during the wait.
U.S. Earnings flood
Earnings are set to be the most important influence for U.S indices this week. The calendar will peak, both in numerical terms and on density of heavyweights.
Beginning with Caterpillar (NYSE:CAT) on Tuesday reports build to a crescendo with Boeing (NYSE:BA), Microsoft (NASDAQ:MSFT) and Ford (NYSE:F) on Wednesday and Amazon (NASDAQ:AMZN), Alphabet (NASDAQ:GOOGL) and Intel (NASDAQ:INTC) on Thursday.
Whilst aggregate growth rates are heading visibly lower from the first quarter, a more stable week in geopolitics is unlikely to see investors quibble with a 22% rise in Q3 compared to 2017 after about 25% in Q2. The performance of the dominant names above will help decide whether or how U.S. indices continue to recoup ground ceded in the first couple of weeks of October.
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