The nomination of Italy’s new Prime Minister was the main driver in the FX market last week, as investors were getting anxious about the fiscal plan that the populist coalition government has promised to put in place.
As a result, the single currency had a complicated week as investors fled European assets - and risky ones in general - and took shelter in safe haven assets. Consequently, the Japanese yen and the Swiss franc were in good demand (up 1.31% and 0.50% against the greenback during last week). The greenback also benefited from the deterioration of the risk environment but gains were rather limited against the backdrop of falling US treasury rates and uncertainty stemming from the hesitations of the Trump administration on geopolitical subject.
Regarding the Italian situation, it is difficult to say whether the new government will effectively implement the campaign promises of both the 5-Star movement and the League, which would expand the country’s budget deficit (cancellation of pension reform, flattening tax, increased spending, tighter immigration policy, etc). Brussels is quite worried Giuseppe Conte’s government will seek confrontation and claim back Italy’s sovereignty on specific matters. Even though the chances that the new government will implement their promises, we think that there is plenty of room for further debasement of the euro, especially against the Swiss franc and the dollar.
Last Friday, the single currency extended losses against most of its peers as it fell the most against the Swiss franc (-0.70%), the Japanese yen (-0.65%) and the US dollar (-0.60%).
Regarding EUR/USD, even though we maintain our short bias, mostly because of the divergence in monetary policy, the latest developments in the bond market together with the stagnation of Fed expectations suggest that the dollar will be limited. Indeed, the entire US yield curve has kept shifting lower with the 2-Year yield falling 7.7bps on the week, while the 10-Year one gave up 13.5bps to reach 2.93%, the lowest level since May 4th.
Long story short, we maintain our short EUR/CHF and USD/CHF bias and remain short EUR in short-term. On the long-term, this is different story, as we believe the ECB won’t derail the normalisation process, which would ultimately be euro positive in the medium to long-term.
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