Italy sets the scene for another week

Summary

Italian debt sets the scene for yields to dominate markets for another week.

Italy’s “Fair” signal

Italy’s coalition government may have inadvertently dropped some clues about its precise level of concern over financial market conditions. As speculators pile on the pressure, sending 10-year BTP yields straining to new 4½ year highs and bringing a definitive end to an easier spell for stressed credit, the broad anticipation remains that political leaders will blink. It only takes a look at Italian assets to realise that point hasn’t been reached yet. It also makes sense to expect the coalition’s resolve regarding the 2.4% of GDP deficit target and its confrontational attitude, to last well past the 15^th October deadline for a draft budget. But by cautioning rating agencies to be “fair", the government has called attention to possible crystallisation of market rating pressure, if Moody’s and Standard & Poor’s were to underscore deteriorating credit by cutting ratings

Italian output check

Curve flattening should also come into sharper focus in Italy, after short-term bond yields zipped higher earlier. The term structure points to early-2018 green shoots having been extinguished. Backing could come from industrial output data on Wednesday. The market has pencilled in an 0.8% bounce for August after July’s unexpectedly -1.8%, reversal, with manufacturing sentiment also weakening to the worst in about two years. Should the lower end of forecasts, pointing to a -0.5% print, prevail, it will fuel BTP selling further. Apart from built-in relief valves, like profit taking, it’s difficult to spot much relief from the most recent pressure on Italian assets. Without a change of tone from Rome, Italian stock and bonds declines appear to have enough momentum for another weekly fall.

Yields slow, investors rotate

The negative start to the week more broadly looks ominous after Friday’s hasty flight to safety but a few points can limit the worst extent of follow-on selling. On Friday, broader U.S. stock markets declined to follow the lead of technology, communication, and e-commerce sectors dominated by FAANG group. This enabled the S&P 500 to avoid a close at its worst intraday levels. Investors also signalled favour for North American banks, ahead of quarterly reports from a clutch of the largest U.S. lenders at the end of the week. Furthermore, U.S. 10-year Treasury yields sharply rejected levels above 3.2480%, failing to continue the magnitude of moves to their latest 4-year highs. There were just 2 ticks between the last before Friday’s close, decelerating from double-digit basis point jumps over the course of last week. Technical indicators higher up the curve also became glaringly oversold last week, whilst fundamentally, in many ways, markets are overreacting to ‘unchanged’ inflation growth and still ‘gradual’ Fed tightening. Treasurys’ cascade lower is probably nowhere near over. Traders are beginning to look at 3.5%. But the rate of the sell-off has not gone exponential and the main chance is that yields will soon resume the more orderly rise seen over recent months.

Beijing stands pat on yuan

Judging by its stop-start progress for most of the year, the greenback should be the weakest link of the yield-dollar-inflation complex this week. There’s little clear sign of fatigue against notable emerging currencies though, with rouble, rand and INR following the yuan lower. Beijing’s first fix for a week, after a break filled with much global drama, was the lowest since May, and it’s rare to find much conviction that yuan weakness will play no role in Beijing’s response to rising economic, trade and financial pressures. Still, the FX authority avoided the psychological 6.90 yuan per dollar mark and it is clear renminbi weakness remains judicious for now. Elsewhere, support for Brazilian assets including the real, has been bolstered by a far-right, albeit market-friendly candidate getting through to the second round of presidential elections. That also weakens one of the recent geopolitical dollar props.

UK GDP is first sterling watch point

A quieter economic data release schedule for most of the week won’t contain much interest for most participants before Wednesday’s monthly UK growth data. Aside from Brexit platitudes from both Brussels and Westminster, these could be the preeminent catalyst for sterling, which consolidates after running almost 1.4% higher in October up till Friday. Forecasters notch likely growth at the same 0.6% rate as July. They are most optimistic about manufacturing sector output, which is called to swing higher to a 0.1% print in August after a 0.2% retreat in July. Construction is seen weakening further, whilst the broad industrial aggregate is seen unchanged with 0.1% growth. Sterling’s basing profile could be damaged should any of these expectations be dashed. Technically, that would require a breached Friday low ($1.3001) and also invalidation of the one before, 3^rd October’s four-week low at $1.2922. Cable rose during both sessions.