FX market outlook

FX market outlook

Posted on Tuesday, May 29 2018 at 9:38 am GMT+0000

Euro retreat in full swing as Italian political uncertainties dominate

Here are the latest developments in global markets:

  • FOREX: The US dollar index – which tracks the greenback’s performance against a basket of six major currencies, edged 0.2% higher on Tuesday, touching its best levels since November. The euro meanwhile remained on the back foot, as the increasing probability for early elections in Italy dampened the currency’s appeal.
  • STOCKS: US markets remained closed on Monday in celebration of the Memorial Day holiday. They look set to open lower today, as futures tracking the Dow Jones, S&P 500, and Nasdaq 100 are all currently flashing red. The prospect for early elections in Italy appears to be overshadowing positive signals on the geopolitical front that the US-North Korea summit may still happen as early as next month. The negative sentiment was evident in Asia, where most markets closed lower. In Japan, the Nikkei 225 and the Topix fell by 0.55% and 0.48% respectively, as the yen’s recent surge will likely cloud the outlook for Japanese exporting firms. Meanwhile in Hong Kong, the Hang Seng was down by 0.92%. In Europe, futures tracking all the major indices were a sea of red, pointing to a much lower open for all these benchmarks today amid political uncertainties in Italy.
  • COMMODITIES: Oil prices are higher on Tuesday, with WTI and Brent climbing by 0.5% and 0.35% respectively, both recovering some of the astounding losses they postedon Monday and Friday. The losses came on the back of hints from Saudi Arabia and Russia that they could soon increase their production in order to offset any potential supply outages from Venezuela and Iran, pouring cold water on expectations for reduced supply in the market. In precious metals, gold is higher today, but by less than 0.1%. The metal has crossed back below the psychological $1300 territory, after it met resistance at its 200-day moving average on Friday. Gold continues to remain unfazed by uncertainties in the European political spectrum, with investors seemingly preferring the Japanese yen as a safe-haven play.

Major movers: Euro continues to bleed on politics; yen extends rebound

The single European currency continued its downfall on Monday, losing ground against all its major counterparts as the uncertainty surrounding the Italian political scene reached new peaks. It appears the nation will head to early elections as the two anti-establishment parties abandoned their attempts to form a coalition. This came after Italian President Mattarella’s rejected their proposed candidate for Economy Minister, who was seen as holding Eurosceptic views.

The market response of pushing the euro lower appears justified, as this story is shaping up to be one more existential threat for the Eurozone. In the event of early elections, Eurosceptic and populist parties could gain an even bigger share of the voting pie, increasing the risk that policies like calling a referendum on the euro start being discussed again in Eurozone’s third largest economy. Early elections are rumored to take place between August and September. Yields on Italian 10-year bonds raced even higher, touching highs last seen in 2014, as investors continued to flee the nation’s bond market.

As for the euro, while its longer-term outlook remains a bright one, the currency’s near-term prospects continue to be clouded by a combination of political uncertainties, a European economy losing momentum, and an ECB that appears increasingly more cautious to normalize. More downside cannot be ruled out in the near-term, especially if the Italian narrative remains at the forefront and the ECB “hesitant”.

Turning to the yen, which is perceived as a safe-haven asset, it has probably been the biggest beneficiary from uncertainties in Europe. Euro/yen is down nearly 0.7% on Tuesday, touching a fresh 11-month low. Meanwhile, dollar/yen is lower by 0.5% as well, even despite the dollar posting modest gains against other currencies.

In fact, the dollar index reached its highest level since November yesterday and is building on those gains today, climbing by another 0.2%. The latest surge may be viewed more as euro weakness rather than dollar strength, considering that the euro holds more than 50% of the weight in the dollar index.

Day ahead: US consumer confidence due; Italian politics and geopolitics closely monitored

Tuesday’s calendar is relatively quiet in terms of releases, with consumer confidence data out of the US perhaps being the reading attracting most attention. Beyond economic data, the political situation in Italy and other geopolitical developments will be eyed; these maybe have the greatest capacity to act as market movers in today’s trading.

The ECB will be releasing monthly data on lending and money supply at 0800 GMT, while the Bank’s board member Sabine Lautenschlager will be speaking about monetary policy in Frankfurt at 1530 GMT; the city is hosting a Finance Summit.

Data on US housing prices for March as gauged by the CaseShiller indices will be made public at 1300 GMT, while consumer confidence figures out of the world’s largest economy are scheduled for release at 1400 GMT. The index measuring consumer morale is projected to fall to 128.0 in May, from April’s 128.7.

Italian President Sergio Mattarella’s decision to veto the 5-Star Movement and League’s nominee for the position of economy minister – on the grounds of him being a critic of the euro currency – was not well received by the two parties, which now seem to be preparing for fresh elections. The two anti-establishment parties have been gaining momentum lately and new elections may see them come out even stronger. The euro is expected to be sensitive to updates on the issue, which will be closely monitored by market participants.

In geopolitics, a US-North Korea summit may not be dead after all, with the parties involved seemingly making efforts to revive the Trump-Kim meeting. Meanwhile, the stage is set for more trade talks between the US and China in the day to come.

It is important to note that political and geopolitical developments are not just of interest to currency traders, but also to equity and fixed income ones.