European Markets Rocked By Last-Minute Italian Budget Turmoil

European stock markets and the euro tumbled on Thursday after an early morning report that Italy’s long-awaited budget was facing a delay added to a groggy post-FOMC global mood after the third U.S. interest rate hike of the year.

Italian bonds and stocks fell along with the euro as the Italian budget process, and its looming midnight deadline, were thrown into turmoil after League leader Matteo Salvini decided to support a last minute push by Luigi Di Maio of the Five Star Movement for extra spending in the form of a 2.4% budget deficit next year, while Finance Minister Giovanni Tria is fighting to keep the shortfall below 2%, and is reportedly ready to resign.

The nation’s benchmark stock index tumbled as much as 2%, the most in more than a month...

... and the nation’s two-year yield jumped as much as 20 basis points to 0.97 percent, after Corriere della Sera reported on Thursday morning that the meeting on the 2019 budget may be postponed owing to “the new complications” in reaching agreement on the deficit with the League said to join the Five Star Movement in seeking a 2.4% deficit target for 2019.

Italy’s populist deputy prime ministers, Luigi Di Maio and Matteo Salvini, have been pitted against Finance Minister Giovanni Tria over how far public finances in the country can be stretched to meet election pledges made by Di Maio’s Five Star Movement and Salvini’s League parties. The two demand a budget deficit of 2.4% meanwhile Italy's technocratic Finance Minister Giovanni Tria - who has been seeking to hold the deficit to 1.6% of GDP - is said to be ready to resign and is sticking to his deficit target.

“If Tria is no longer part of the project, we’ll find another finance minister,” Riccardo Molinari, head of League lawmakers in the lower house of parliament, tells RAI television according to newswire Ansa.

According to the latest news, a full cabinet budget meeting will take place at 8 p.m. local time, while a top government pre-meeting is scheduled for 4 p.m. local time, although this may change. Speaking from Tunis, Salvini says that it worth pushing the deficit beyond 2 percent to deliver for voters. "Italians’ right to work and happiness is much more important that numbers," he said.

Meanwhile, Di Maio, who leads the biggest party in the coalition, said there’s no point being in government if you can’t deliver on your policy pledges, Ansa newswire reports.

As a result of the latest Italian turmoil, the yield on 10-year bonds increased 10 basis points to 2.96%, the highest level since Sept. 17. The yield spread over German bunds climbed 10 basis points to 243 basis points.

Following the initial selloff, Italian Deputy Minister Luigi Di Maio confirmed that a cabinet meeting over budget targets was still planned for later, dismissing the Corriere newspaper which said it could be delayed, but it couldn’t soothe the markets, especially after conflicting reports that the economy ministry was forced to deny its chief Giovanni Tria, an academic who doesn’t belong to any one party, had threatened to resign.

“It is very fluid and it is changing by the minute it seems,” State Street Global Advisers’ head of EMEA macro strategy Tim Graf said. “Even if things get resolved positively today, Italy is not a situation that is going to go away,” he added, pointing to the still growing popularity of the country’s fractious anti-establishment coalition government.

The return of Italian budget turmoil weighed on the rest of Europe too. Europe's STOXX 600 index was down 0.5% while the euro skidded all the way down past $1.17.

European banking stocks dropped as much as 1.5%, making it the worst-performing sector within the Stoxx Europe 600. Italian banks lead the decline with UBI -3.3%, Intesa Sanpaolo -3%, Banco BPM -3% and Unicredit -2.9% the worst-performing stocks. The headline risk has threatened the Stoxx 600 Banks Index’s recent recovery as it is getting closer to its dominating 2018-downtrend again after leaving the bearish area just six trading days ago.

Earlier Asian markets showed a guarded response to Fed’s forward guidance with the Hang Seng index reversing gains after Hong Kong banks raised lending rates first time in over a decade. Japan's Topix index lost 0.8%, while the Shanghai Composite slips 0.4%.

The return of the Italian drama gave the dollar a boost after it had only managed a lazy gain overnight after the Federal Reserve hiked U.S. interest rates by another 25 basis points to a range of 2 percent to 2.25 percent. The dollar index rose above 94.5, while the Bloomberg Dollar Spot Index rose to the highest level in more than a week as Italian politics weighed on the euro, which managed to pare some losses on finding support from strong German regional inflation data. The greenback advanced versus all Group-of-10 peers except the yen amid stronger Treasuries and with stock markets in defensive mode. Emerging-market currencies lingered near a three-week high as commodities consolidated recent gains.

The Australian dollar seen as a barometer of global investor risk appetite and Chinese demand for goods, fell 0.4 percent to $0.7226, its lowest since Sept. 19 and not far off its 2-1/2 year lows of $0.7085 hit earlier this month. The Canadian loonie fell after Trump slams Canada trade negotiations, kiwi weakens as RBNZ keeps door open for rate cut. KRW leads Asian emerging-currency gains after BOK chief calls for less monetary easing.  The Yuan strengthened against the dollar as PBOC drained 60 billion of liquidity and refrained from following Fed hike.

The US 10-year TSY yield hovered near 3.05%, while Germany’s 10-year yield sank 2bps to 0.51 percent, the biggest drop ion more than two weeks. The spread of Italy’s 10-year bonds over Germany’s climbed 10 basis points.

In the latest Brexit news, UK PM May Spokesman said PM May and US President Trump agreed that Brexit provides a wonderful opportunity for an ambitious UK-US free trade deal. More notably, May is reportedly losing support for a no-deal Brexit if EU discussions fail, according to sources. Sources suggest there are concerns that May will stick to her promise to force a no-deal Brexit if Europe rejects her Chequers plan again.

The oil market is still in positive territory, with Brent trading around the USD 82/bbl area. Some pressure was offered to the fossil fuel, however, by source reports from Saudi Arabia saying that they are set to increase production by 200-300k BPD to make up for lost Iranian supply for the next 2 months. In the metals scope, gold is in the green and trading within a thin range after the yellow metal hit 2 week lows in the previous session. Chinese steel rebar has fallen by over 1%, hitting a two week low, with aluminium also slipping to a month long low as demand continues to dry up for the construction materials ahead of the week-long Chinese holiday,

Market Snapshot

  • S&P 500 futures little changed at 2,910.75
  • STOXX Europe 600 down 0.4% to 383.65
  • MXAP down 0.4% to 165.14
  • MXAPJ down 0.09% to 525.77
  • Nikkei down 1% to 23,796.74
  • Topix down 1.2% to 1,800.11
  • Hang Seng Index down 0.4% to 27,715.67
  • Shanghai Composite down 0.5% to 2,791.78
  • Sensex down 0.5% to 36,376.61
  • Australia S&P/ASX 200 down 0.2% to 6,181.22
  • Kospi up 0.7% to 2,355.43
  • Brent futures up 0.6% to $81.80/bbl
  • Gold spot up 0.2% to $1,196.40
  • U.S. Dollar Index up 0.3% to 94.51
  • German 10Y yield fell 2.3 bps to 0.503%
  • Euro down 0.2% to $1.1714
  • Italian 10Y yield fell 1.8 bps to 2.499%
  • Spanish 10Y yield rose 0.7 bps to 1.53%

Top Overnight News from Bloomberg

  • Italy’s government is due to decide on targets for the 2019 budget deficit, debt level and growth by midnight Thursday, but negotiations have been hit by a last-minute demand for extra spending by the coalition’s two deputy prime ministers
  • Fed Chair Jerome Powell praised the value of gradual rate increases, which have allowed the Fed to watch their policy moves play out, after the central bank raised rates by 25bps. In their statement, Fed officials dropped a reference to “accommodative” policy
  • U.S. President Donald Trump announced he has reached an agreement with Japan Prime Minister Shinzo Abe to open trade talks. The two countries have agreed that sanctions on auto exports won’t be applied while the talks take place, Abe said
  • Trump said he and Chinese President Xi Jinping might not be friends anymore after he accused Beijing of trying to interfere in U.S. congressional elections in November
  • New Zealand’s central bank held interest rates at a record low and signaled it’s prepared to cut them if the economy fails to gather pace
  • The European Union has started exploring what emergency measures it may need to take without the U.K.’s cooperation in the case of a “no deal” Brexit, according to people familiar with a meeting between the bloc’s 27 remaining governments
  • French President Emmanuel Macron said he’d welcome Britain back should its voters decide in a second referendum to stay in the European Union
  • Euro-area economic confidence slid for a ninth month, the longest streak of declines since 2011, as protectionism and political uncertainty cast a cloud over the outlook

Asian stocks were indecisive following a lacklustre lead from Wall St. where the major bourses ended the day with losses after a mixed-perceived FOMC. ASX 200 (Unch) was subdued by a pullback in commodity names, while Nikkei 225 (-0.5%) swung between gains and losses at the whim of a choppy currency. Shanghai Comp (-0.4%) and Hang Seng (-0.4%) also flip-flopped with the region somewhat cautious as it digested the FOMC and a lock-step hike by the HKMA, while the PBoC skipped open market operations again for a net daily drain of CNY 60bln. Finally, 10yr JGBs tracked US Treasuries higher with prices also supported amid the BoJ’s Rinban announcement for JPY 880bln in JGBs across the curve before hitting resistance at 150.20.

Top Asian News

  • HSBC Raises Hong Kong Lending Rate for First Time in 12 Years
  • Bank Indonesia Hikes Rates for Fifth Time to Curb Currency Rout
  • India’s RBI Announces Measures to Ease Bank Liquidity Shortage
  • Philippines Delivers Another 50 Basis-Point Rate Hike

European equities have been driven by mixed reports from Italy this morning ahead of their upcoming budget. This led equities to start the day in the red on suggestions of possible resignation of the Italian Finance Minister, and/or a delay to today’s presentation.  Some reprieve was offered by a rejection of these reports, but most major bourses are still in the red, with the FTSE MIB leading the losses. The FTSE is bucking the trend as a result of the softer GBP. Italian banks have been hit the hardest by the budget dispute reports from Italy, as the rise in Italian yields has pushed Unicredit (-3%), Banco BPM (-2.8%) and Intesa Sanpaolo (-2.7%) close to the foot of the Stoxx 600. These stocks are languishing in the red alongside Indivior (-10%), who is leading the losses in the Stoxx 600, after a guidance cut in late European trade yesterday

Top European News

  • Euro-Area Economic Confidence Slides as Global Risks Increase
  • Germany Feels the Trade-War Heat as Economic Outlook Slashed
  • AMS Drops After UBS Cuts PT on Outlook for 3D Sensing in Android
  • Mediobanca Says Bollore Group Is Leaving Shareholder Pact

In currencies, EUR was not the biggest G10 lose in the FOMC aftermath vs a broadly firm USD (DXY back above 94.500 and up to 94.645 at best), but struggling to maintain 1.1700+ status amidst more Italian fiscal bickering in Rome between Economy Minister Tria and the more anti-austerity factions of the coalition Government. The single currency has derived some underlying support from firmer than expected German state CPI reports implying an upside skew to the national print, while hefty option expiry interest at 1.1700-05 (1.35 bn) may also be keeping the headline pair afloat. GBP/AUD/CHF/CAD/NZD - The major underperformers against the Greenback, partly on Fed policy guidance reaffirming a final and 4th 25 bp hike this year, followed by 3 more in 2019 and another the year after, but also on other factors. Cable is teetering above 1.3100 as Brexit uncertainty persists, while Aud/Usd is slipping from the 0.7250 level that has been pivotal amidst the ongoing US-China trade rift. The Franc is only just holding circa 0.9700 and around 1.1350 vs the Eur, conscious that the SNB will be watching out for any Roman repercussions and ready to intervene if the Chf strengthens excessively on safe-haven grounds. Elsewhere, the Loonie has lost much of its crude traction following latest NAFTA news that suggests little prospect of a deal anytime soon, with Usd/Cad up over 1.3050 ahead of Canadian average weekly earnings data and a speech from BoC’s Poloz later tonight, while the Kiwi only got a fleeting boost from a relatively upbeat RNBZ assessment of the economy and core inflation as the OCR outlook remained neutral. Hence, Nzd/Usd has reverted to its 0.6650 axis and veering south. JPY - Holding up much better than the rest in contrast to recent sessions, even though BoJ Governor Kuroda has maintained a dovish stance with powerful easing still appropriate, and it appears that technical impulses may be impacting after the latest rejection of 113.00+ levels. The headline pair retreated towards 112.50 before finding some underlying bids ahead of a 112.35 Fib and a decent expiry between 112.50-40 (1.1 bn), while Eur/Jpy topped out in advance of 133.00 and a quadruple top just above the big figure.

In commodities, the oil market is still in positive territory, with Brent trading around the USD 82/bbl area. Some pressure was offered to the fossil fuel, however, by source reports from Saudi Arabia saying that they are set to increase production by 200-300k BPD to make up for lost Iranian supply for the next 2 months. In the metals scope, gold is in the green and trading within a thin range after the yellow metal hit 2 week lows in the previous session. Chinese steel rebar has fallen by over 1%, hitting a two week low, with aluminium also slipping to a month long low as demand continues to dry up for the construction materials ahead of the week-long Chinese holiday.

Looking at the day ahead, we get the third and final Q2 GDP (+4.2% qoq saar expected) and core PCE (+2.0% qoq saar expected) revisions, August advance goods trade balance, August wholesale inventories, preliminary August durable and capital goods orders, weekly initial jobless claims, August pending home sales and September Kansas City Fed manufacturing survey. It’s a busy day ahead for central bank speak too. Over at the BoE we’re due to hear separately from Haldane and Carney, while at the ECB we’ve got Draghi, Lane and Praet all due to speak. At the Fed Kaplan is due to speak at a minority banking forum this evening followed by Powell when he is due to make brief remarks on the US economy at a senate event. This may well all play second fiddle to Italy though depending on what happens with their budget. The 10y BTP auction just prior to this should be an interesting event to watch also to gauge appetite.

US Event Calendar

  • 8:30am: Advance Goods Trade Balance, est. $70.6b deficit, prior $72.2b deficit, revised $72.0b deficit
  • 8:30am: Wholesale Inventories MoM, est. 0.3%, prior 0.6%; Retail Inventories MoM, prior 0.4%, revised 0.5%
  • 8:30am: GDP Annualized QoQ, est. 4.2%, prior 4.2%; Personal Consumption, est. 3.8%, prior 3.8%
  • 8:30am: Core PCE QoQ, est. 2.0%, prior 2.0%
  • 8:30am: Durable Goods Orders, est. 2.0%, prior -1.7%; Durables Ex Transportation, est. 0.4%, prior 0.1%
  • 8:30am: Cap Goods Orders Nondef Ex Air, est. 0.35%, prior 1.6%; Cap Goods Ship Nondef Ex Air, est. 0.5%, prior 1.0%
  • 8:30am: Initial Jobless Claims, est. 210,000, prior 201,000; Continuing Claims, est. 1.68m, prior 1.65m
  • 9:45am: Bloomberg Consumer Comfort, prior 60.2
  • 10am: Pending Home Sales MoM, est. -0.5%, prior -0.7%; Pending Home Sales NSA YoY, est. -1.0%, prior -0.5%
  • 11am: Kansas City Fed Manf. Activity, est. 16.5, prior 14

DB's Jim Reid concludes the overnight wrap

Today is all about the long awaited Italian budget and to a lesser extent German inflation but last night was all about the Fed. We’ll get to the Fed in a second but the latest on the Italian budget may come out just after we go to print as it often does. Before that here’s what we know at the moment on another day of conflicting headlines. Finance Minister Tria did say that the budget will include citizens’ income measures which likely pushes it above his desired 1.6%. Perhaps more notable was the comment from EU Commissioner Moscovici before that. Quoted in la Stampa, Moscovici said that Italy’s deficit must stay below 2%. So that would imply some breathing room for Tria above his 1.6% target and therefore potentially defuse the various political pressures. Just as Europe was going home though on-line editions of the main local newspapers (Corriere, Repubblica, Messaggero) reported that the M5S and the NL have actually already agreed on a 2.4% deficit, some 0.8% above Tria’s target and 0.4% above where the EU seem just about willing to tolerate. There’s been no subsequent headlines overnight but they’ve tended to come out just as we go to print so we may see a fresh round shortly. Are yesterday’s developments posturing ahead of a negotiated compromise later today? We shall hopefully see this afternoon when things all come to a head. The press has reported that the cabinet is due to meet this afternoon, with a press release with the new fiscal targets and growth projections likely to be released by this evening. Tria and President Conte may hold a press conference to present the plan as well. Yesterday, 10 year BTPs again outperformed (-1.9bps) but were comfortably off the lows for the day as a few nerves set in late in the session. Still, they remain 37.7bps off their August peaks.

Back to the Fed and as expected the FOMC raised short-term interest rates by 25 basis points and dropped the reference to monetary policy being “accommodative”. The dot plot showed firmer expectations by committee members for another rate hike in December, with 12 of 16 dots agreeing with our expectations for another hike. The committee also nudged up their median forecast for the long-run fed funds rate to 3% from 2.9%. Chair Powell also discussed tariffs, the counter-cyclical capital buffer, and another potential tweak to the IOER rate to ensure that fed funds continues to trade in its target band, but mostly avoided saying anything new and left the door open for future decisions.

At the margin, these changes could be seen as either dovish or hawkish. Dovish, because by removing the reference to “accommodative,” policymakers are implicitly suggesting that we are closer to neutral and therefore closer to the eventual end of the tightening cycle. Hawkish, because the dots moved up slightly and Chair Powell said that the neutral interest rate may be being underestimated. Net-net, the decision and subsequent press conference confirmed our expectations and did not spark much volatility in markets even if yields fell afterwards indicating the market saw it more dovishly. DB’s Peter Hooper last night confirmed that the meeting reaffirmed his view for a hike in December and then a roughly quarterly pace of rate hikes through 2019.

Fed funds futures were also marginally lower, with the implied-rate by end-2019 around 2 basis points lower. The market continues to undershoot the Fed’s median dot, with around 1.8 hikes currently priced in for 2019. The dollar vacillated after the decision and during the press conference, but ultimately closed +0.06% stronger. Yields rallied, with the 10-year Treasury yield down 4.8bps (4.2bps after the rate hike) and the 2s10s curve 2.4bps flatter. Equities shed intraday gains to close lower, with the S&P 500, DOW, and NADAQ closing -0.33%, -0.40%, and -0.21%, respectively. Interest-rate sensitive sectors led declines, with banks shedding -1.52%.

Asia has largely followed the lead from those post-FOMC declines on Wall Street last night. The Nikkei (-0.61%), Hang Seng (-0.45%), Shanghai Comp (-0.39%) and ASX (-0.05%) are all lower with only the KOSPI (+0.36%) currently holding onto gains (albeit reopening following a holiday). Futures in the US are broadly flat while Asia FX is having a stronger overnight session with the likes of the South Korean Won (+0.42%) and Taiwanese Dollar (+0.37%) advancing.

News yesterday that China was to reduce import tariffs on some products starting from November hasn’t seen much follow through in markets while the other news overnight has come from the sidelines of the UN meeting where President Trump and Japan PM Abe have reached an agreement to open bilateral trade talks. On the flip side of that Trump confirmed last night that he had rejected a one-on-one meeting with Canada PM Trudeau at the UN meeting due to dissatisfaction over trade negotiations – which clearly won’t help Canada’s NAFTA hopes.

Prior to the Fed yesterday, markets elsewhere spent much of the session treading water. The bond sell-off finally abated with  Bunds ending yesterday 1.7bps lower at 0.524% with yields elsewhere in Europe generally down a similar amount. Treasuries were also very modestly stronger going into the Fed before rallying further as noted above.

As for equity markets yesterday in Europe, the STOXX 600 settled for a +0.30% gain and the DAX a +0.09% gain. The FTSE MIB (-0.10%) actually spent the whole session in the red despite BTPs having a decent day. Comments from President Trump at the UN Security Council briefing saying that “we found that China has been attempting to interfere in our upcoming 2018 election” did little to impact markets despite the headlines looking like a reasonable ratchet up in pressure on China considering it was at a UN meeting. Elsewhere, the euro (-0.24%) – although paring heavier losses – struggled for much of the session. A  spokesman for German Chancellor Angela Merkel said that the Chancellor is not considering a confidence vote despite the defeat of her caucus leader candidate. It is however a situation clearly worth watching closely now with a potential confidence vote now being talked about a lot more in the wake of that setback.

Brexit headlines also got some more attention yesterday. Media outlets reported that the EU is intensifying work on its “no-deal” plans while simultaneously pushing back against Prime Minister May’s Chequers proposal, as they consider it to deviate too much from EU single market rules. Adding another layer of complexity was opposition leader Jeremy Corbyn, who reportedly told May that any Brexit deal must also keep the UK in the EU’s customs union.

After markets closed yesterday, Argentina and the IMF announced adjustments to the ongoing bailout program. The size of the credit line will increase from $50bn to $57bn over the next 3 years, with more front-loading of disbursements. Another $19bn will be available before end-2019, more than doubling the previously-available firepower. The authorities will allow the currency to float more, though the central bank reserves the right to intervene in response to “extreme overshooting.” They will also target monetary aggregates instead of interest rates, and it will be interesting to see how the market responds to the new regime when the Peso opens for trading at 2pm BST.

Elsewhere, the economic data that was out yesterday prior to the Fed did little to move the dial. In the US, August new home sales printed at a stronger than expected +3.5% mom (vs. +0.5% expected). In Europe, the UK’s CBI retail reported sales data for September – while down from August – still came in at a better than expected +23 (vs. +19 expected). In France, consumer confidence for September fell slightly to 94 from 97.

Finally to the day ahead, which is a busy one for data releases. This morning in Europe we’ve got the October consumer confidence print in Germany followed by the August M3 money supply reading for the euro area. September confidence indicators for the euro area follow and then in the early afternoon we get the flash September CPI reading for Germany. A +0.1% mom reading is expected which should hold the annual reading at +1.9% yoy. In the US, we then get the third and final Q2 GDP (+4.2% qoq saar expected) and core PCE (+2.0% qoq saar expected) revisions, August advance goods trade balance, August wholesale inventories, preliminary August durable and capital goods orders, weekly initial jobless claims, August pending home sales and September Kansas City Fed manufacturing survey. It’s a busy day ahead for central bank speak too. Over at the BoE we’re due to hear separately from Haldane and Carney, while at the ECB we’ve got Draghi, Lane and Praet all due to speak. At the Fed Kaplan is due to speak at a minority banking forum this evening followed by Powell when he is due to make brief remarks on the US economy at a senate event. This may well all play second fiddle to Italy though depending on what happens with their budget. The 10y BTP auction just prior to this should be an interesting event to watch also to gauge appetite.