FX Markets Signal Brexit-Like Disruption As Italy Referendum Looms

FX traders are pricing in as big a potential disruption event for Italy's referendum as they did (correctly) for the Brexit vote. So-called 'currency-vigilantes' are buying EURUSD protection across the Dec 4th date of the vote in size as Italian bond spreads (over Bunds) push to 30-month highs.

Anticipated euro-dollar price swings for the period of the Italian vote surged. Two-week implied volatility climbed to 12.5 percent, approaching the highest since the aftermath of the Brexit vote in June... and the premium for that protection across the referendum date is now at its highest since Brexit...


As Bloomberg reports, selling the euro before Italy’s vote “makes a lot of sense given the potential for more expansionary fiscal and tighter monetary policy in the U.S., coupled with the increased focus on political risk and the increased likelihood of more policy from the ECB,” said James Athey, a money manager in London at Aberdeen Asset Management Plc, which oversees more than $400 billion.

“For FX, politics is the new economics,” HSBC Holdings Plc analysts including David Bloom wrote in a note last week. “QE has constrained the bond market, distorted equity prices and narrowed yield differentials. This means FX is uniquely placed to reflect political developments.”

Trump’s election has boosted speculation that Italians will reject the reforms on which Renzi has staked his political future. Deutsche Bank AG economists say there’s a 60 percent chance the vote will fail, while political risk-advisory firm Eurasia Group changed its call this month, and now assigns a 55 percent probability to a “no” vote.

“Markets are anticipating two risks at the moment: reflation and populism in Europe,” said Marc Chandler, head of currency strategy at Brown Brothers Harriman & Co. in New York. “If one thinks that the Italian referendum is going to be lost, and it’s not priced in, selling the euro -- which is also being weighed down by other factors -- seems the path of least resistance compared with a rate position.”