Political Disarray in Rome amp Washington

As the governments of Italy and the United States sustain a new crisis of political gamesmanship and budget disarray, October 4, 15 and 17th are the latest key dates to watch by FX traders.

Italy’s 5-month old parliament collapsed on Sunday after centre right leader Berlusconi ordered his ministers to resign over negotiations on the budget, including the controversial VAT hike, which was aimed at preventing a breach of European deficit rules. PM Letta will try to form an alternative majority, with the help of parliamentarians from Berlusconi’s Forza Italia, from Beppe Grillo’s anti-establishment Five Star Movement and even centrists led by former prime minister Mario Monti. There is the possibility that not all of Mr Berlusconi’s MPs will remain loyal as he faces a year of house arrest or performing community service.

October 4

Possible date the Italian senate may vote to strip Silvio Berlusconi of his Forza Italia seat in the upper house. If the vote goes ahead, Berlusconi’s followers threaten to stage mass resignations.

October 14

Of extreme importance to financial markets is for Italy to submit its 2014 budget to the European Commission on October 14 before seeking parliamentary approval. Rome must keep the debt deficit to remain below 3% of GDP. But before the budget is set, a new government must be in place. One of the “worst case” scenarios is the failure of PM Letta to form an alternative government and lead to the dissolution of parliament.

Rating manoeuvres

S&P is the last credit agency of the major three agencies to have downgraded Italy’s sovereign rating, dropping it by one notch to BBB in July of this year. This is a similar level of rating to Moody’s Baa2 after the downgrade of July of 2012. This means that Fitch, whose BBB+ rating for Italy stands one notch above the other two agencies, may be expected to deliver its downgrade after its most recent action was in March of this year. Fitch said last week: “potential collapse of Italy’s ruling coalition government puts the sovereign’s short- and medium-term fiscal policy targets at risk and creates uncertainty at a crucial period when the 2014 budget should be finalised”.

October 17

The US Treasury has set October 17 as the date when the debt ceiling would most likely be breached. Markets are already bracing for a shutdown of the government at midnight October 1^st  as a result of failure to agree on a new budget for 2013-2014. There are already plans for a “partial” government shutdown, which would limit the number of govt. employees to go on furlough. As traders evaluate the seriousness of the government shutdown next week and a debt limit crisis by mid next month, the latter is definitely the more serious concern. A government shutdown would not necessarily halt Social Security payments, but a debt limit crisis could do so, as well as stop veterans benefits, Medicare and Medicaid reimbursements.

As we have learned late last year, the US dollar sustains no direct impact from US budget negotiations. Rather than this being a case of USD resilience, it is a case of euro strength emerging on Sunday despite the collapse of the Italian government and the possible implications to regain access to financial markets. The fact that EURUSD has regained the 1.3550s and GBPUSD has broken above $1.6200 for the first time in seven months is highlighting a new wave of USD weakness, cemented by a Fed policy of arms-behind-its-back.  The USD index has already broken its May 2011 trenedline, looking for the 200-WMA at 79.80, followed by 78.20.