Market Rebound Fades As Italian Budget Details Emerge

The euphoria following the late report that Italy's government had bowed to pressure from the European Union to trim its budget-deficit target, when Corriere della Sera reported that Rome would seek to contain its budget deficit at 2% in 2021, down from 2.4% (with 2019 remaining at 2.4% and 2020 shrinking to 2.2%), has faded across key asset classes and the EURUSD is now barely changed, dropping to 1.1560 after rising as high as 1.1590...

... Italian 10Y bonds have resumed their selloff...

... and the Italian stock market, the FTSE MIB retraced almost of its initial move higher.

Excitement quickly faded after details from the proposed budget proposal said a “minimum” of €10bln is to be set aside for citizens income and that there are no plans to alter the deficit if GDP growth disappoints. This led to investors repeating concerns over fiscal irresponsibility and the possibility of debt/GDP rising over 3% should GDP growth forecasts not come in line. It also hit market sentiment, with equities now flat after having been in positive territory in the early morning. Note, that the DAX is closed for trading on this session for German Unity day.

Enthusiasm was also dented after Deputy Premier Luigi Di Maio said that for his Five Star Movement, “either this is the people’s budget or it’s not worth it,” in remarks to reporters at Rome parliament. Di Maio says budget deficit target at 2.4% confirmed for 2019 and clarified the government position saying that "the discussion in Europe on the budget law is very long. They are not going to say no tomorrow morning." He also made it clear that Italy's words of hope are just that, as the government had no plans to insert in its budget an automatic mechanism to lower the deficit if growth fails to live up to targets.

While over the weekend, economy Minister Giovanni Tria said over the weekend that there would be an automatic stabiliser in the budget that would cut spending should growth be lower than forecasts, Di Maio refuted this and said that "we don’t currently have plans for an automatic stabilizer" and simply said that spending could be cut later should growth turn out to be lower than expected.

Italy's other deputy Premier, Matteo Salvini, also dented enthusiasm when he said that he is certain that starting next year debt will fall "because more people will go back to work," in interview with Canale 5 television. Asked whether govt has gone into reverse on budget, replies: “We have always said that this year we want to maintain at least part of the commitments with Italians" but added that "I don’t give a damn about threats from European Union, France" as "I answer only to Italians."

Even assuming the concession stays, the EU’s response to the revised targets remains a key hurdle for investors as Brussels may still balk at the proposed 2.4% budget busting which then assumes that the Italian economy grows just shy of 2% to reduce the deficit, a very aggressive assumption. As a reminder, the original plan for a deficit target of 2.4% over three years had prompted a stern push-back, with the European Commission Vice President Valdis Dombrovskis saying that it went “substantially beyond" what is allowed.

So for now, all eyes on Europe and the official and final contents of the final budget proposal. Meanwhile, even as Italian and European risk assets faded the initial euphoria, with the Stoxx 50 sliding from opening highs...

... US equity futures traded near session highs, with much of the world in a sea of green.

Meanwhile, the excitement over Italy's potential relent wasn't enough for Asia, where the MSCI Asia Pacific index fell for a third day, with Japanese and South Korean equities leading declines. The rupiah and the rupee remained under pressure on surging oil prices. The rupiah fell to 15,090 to a dollar, its weakest level since the 1998 Asian financial crisis. The rupee slumped past 73 per dollar to reach a fresh all-time low as traders returned from Tuesday’s holiday.

In India, the focus was also back on the country’s financial sector after Prime Minister Narendra Modi’s government took control of IL&FS (Infrastructure Leasing & Financial Services), promising to end the group’s string of defaults.

Investors have been on edge this week with the market impact of European politics and emerging-market strains still high on the agenda. A very close encounter between a U.S. and a Chinese warship in the disputed South China Sea added to tensions between two countries already embroiled in an escalating trade war. Meanwhile, Treasury yields remain near the top of the recent range after Fed Chair Powell welcomed wage growth but expressed confidence that low unemployment won’t spur a takeoff in prices that forces more aggressive tightening.

Elsewhere Aston Martin shares tumbled on their trading debut after an initial public offering valued the company on a par with competitor Ferrari. The Turkish lira also fell after the country’s inflation surged. The pound climbed ahead of a major speech from U.K. Prime Minister Theresa May.

After hitting fresh 4 year highs, Brent dipped back under $85 a barrel after a Reuters report that Saudi Arabia and Russia had agreed to boost output through December.


In overnight central banks news, Fed Chair Powell said a downward yield curve could signal that Fed policy is tight and policy is not that tight at the moment. He said trade tariffs could increase prices but US is not yet seeing effects from trade policy. Powell added gradual rates are meant to balance risks and there is a "remarkably positive outlook" on inflation and employment. Fed's Kaplan said he is happy with one more rate hike this year in December, base case is two next year. He is hopeful the Fed can raise rates to neutral without inverting the yield curve and the US economy is at or past full employment, while he said his view that US GDP will grow at 3% this year, 2.5% next year as fiscal stimulus fades. In regards to oil, he sees more upside risk to prices.

On today's calendar, Lennar and RPM International are among companies reporting earnings; Expected data include mortgage applications and employment change.

Market Snapshot

  • S&P 500 futures up 0.2% to 2,934.50
  • MXAP down 0.6% to 162.72
  • MXAPJ down 0.1% to 515.24
  • Nikkei down 0.7% to 24,110.96
  • Topix down 1.2% to 1,802.73
  • Hang Seng Index down 0.1% to 27,091.26
  • Shanghai Composite up 1.1% to 2,821.35
  • Sensex down 0.6% to 36,311.30
  • Australia S&P/ASX 200 up 0.3% to 6,146.07
  • Kospi down 1.3% to 2,309.57
  • STOXX Europe 600 up 0.3% to 383.03
  • German 10Y yield rose 2.6 bps to 0.448%
  • Euro up 0.2% to $1.1573
  • Italian 10Y yield rose 15.0 bps to 3.08%
  • Spanish 10Y yield fell 1.2 bps to 1.527%
  • Brent futures up 0.2% to $85.00/bbl
  • Gold spot little changed at $1,203.40
  • U.S. Dollar Index down 0.1% to 95.37

Top Overnight News from Bloomberg

  • Italy’s populist government will bow to European Union pressure to reduce its budget deficit to 2 percent of gross domestic product in 2021, reversing plans to maintain a bigger shortfall for the next three years, Corriere della Sera reported, citing a Cabinet meeting
  • Italian bonds may recover from four days of selling after the government signaled it’s bowing to pressure from the European Union to trim a budget deficit target
  • New York state tax authorities have opened an investigation into allegations reported in the New York Times that President Donald Trump and his family created their real estate empire through “instances of outright fraud,” evading taxes on hundreds of millions of dollars
  • Federal Reserve Chairman Jerome Powell welcomed recent increases in Americans’ wages while expressing confidence that low unemployment won’t spur a takeoff in prices that would force him to hike interest rates aggressively
  • Finland’s Olli Rehn joined key European Central Bank decision-makers including Benoit Coeure in stressing the need for flexibility in preparing investors for eventual increases in borrowing costs
  • Britain and the European Union will begin a frantic week of diplomacy on Wednesday aimed at thrashing out the final shape of the Brexit deal. Brexit Secretary Dominic Raab is planning to visit Brussels next week and expects progress on the thorny issue of the Irish border, according to a senior official who declined to be named. Diplomats in Brussels said they expect the contours of the exit agreement to emerge by the middle of next week
  • President Trump participated in dubious tax schemes during the 1990s, including instances of outright fraud, that greatly increased the fortune he received from his parents, an investigation by The New York Times has found
  • Turkey’s consumer inflation climbed near the highest levels since President Recep Tayyip Erdogan came to power 15 years ago, spurring calls for higher interest rates to rein in prices

Asian stocks traded choppy following a mixed lead from the US where the Dow hit all-time highs aided by gains in Intel shares, while Nasdaq was pressured by large-cap tech names tumbling over a percent. ASX 200 (+0.3%) outperformed as miners boosted the index, while Nikkei 225 (-0.7%) was weighed on by auto names with Honda and Toyota falling 3% and 2% respectively, while the index was also mirroring currency fluctuations throughout the session. Elsewhere, Hang Seng (-0.6%) traded lower amid weakness in financial names and as the tech sector failed to support the index following Tencent’s plans to IPO it’s music arm in the US, in what could be one the biggest IPOs to date. Meanwhile, mainland China and South Korea were shut due to public holidays. NEC Director Kudlow said US and China keep talking about trade, while the White House Advisory said China has not made a serious enough effort at appeasing the US.

Top Asian News

  • Dubai Bank Said to Weigh Paying Sberbank Less in Turkey Deal
  • Indonesia Rocked by Volcanic Eruption After Deadly Quake
  • Peer-to-Peer Lending Crash in China Leads to Suicide and Protest
  • Indonesia Central Bank Expects Currency Pressure to Ease in 2019

European equities started the day on the front foot after the early morning risk tone benefited from Italy confirming the debt/GDP target from 2020 at 2.2% vs. the originally quoted 2.4%. This, however, reversed course after the details from their budget proposal said a “minimum” of EUR 10bln is to be set aside for citizens income and that there are no plans to alter the deficit if GDP growth disappoints. This has led to investors repeating concerns over fiscal irresponsibility and the possibility of debt/GDP rising over 3% should GDP growth forecasts not come in line. This hit market sentiment, with equities now flat after having been in positive territory in the early morning. Note, that the DAX is closed for trading on this session for German Unity day. Norsk Hydro and Tesco are leading the losses in Wednesday’s session. The Scandinavian company is being hit by the ceasing of operations at their Alunorte site in Brazil. Tesco is struggling after reporting earnings wherein profit missed expectations.

Top European News

  • U.K. Set for Solid Third Quarter Even as Services Growth Ebbs
  • Japan Waves Goodbye to U.K. as ‘Gateway to Europe’ Post- Brexit
  • Tesco Falls as Overseas Weakness Gives CEO a New Headache
  • Record-Breaking Italian 5G Sale Dents Telecom Carrier Finances

In FX, markets reacted quickly to reports that Italy was seeking a cut to their 2021 deficit/GDP ratio to 2.0% from 2.4%. EUR immediately caught a bid as the reports signal a potential compromise from Italy. The EUR strength weighed more on the Japanese currency than the USD with EUR/JPY and EUR/USD spiking higher by 82 pips and 53 pips respectively. DXY fell to session lows while USD/JPY rose just over 20 pips. Elsewhere, AUD experienced weakness earlier in the session amid a substantial miss in the Australian building approvals with NZD/USD moving lower in sympathy.

In commodities, the source report story suggesting Russia and Saudi Arabia are to boost oil output in December hit the oil market, which started in the green off the back of yesterday’s smaller than expected build in API crude stocks. The crude complex is now flat as suggestions of increased supply halted Brent’s advance over the USD 85/BBL with the benchmark now hovering just below the big figure. The Iraqi Energy Minister said that they will assess increased OPEC output in November. In the metals scope, gold is unchanged after having risen by over 1% in the previous session. The biggest mover in the commodities scope can be found in aluminium, which has rallied to over 5 week highs after Norsk Hydro announced the cessation of operations at their Alunorte site in Brazil, stoking the flames of supply concerns for the industrial metal.

Looking at the day ahead, the US we’ve got the September ADP reading followed closely by those September PMIs and September ISM non-manufacturing

US Event Calendar:

  • 7am: MBA Mortgage Applications, prior 2.9%
  • 8:15am: ADP Employment Change, est. 184,000, prior 163,000
  • 9:45am: Markit US Services PMI, est. 53, prior 52.9
  • 9:45am: Markit US Composite PMI, prior 53.4
  • 10am: ISM Non-Manufacturing Index, est. 58, prior 58.5

Central Banks:

  • 6:30am: Fed’s Evans Speaks in London
  • 8:05am: Fed’s Barkin Speaks at Economic Conference in West Virginia
  • 2pm: Fed’s Brainard Speaks in Chicago about Payment System
  • 2:15pm: Fed’s Mester Speaks at Community Banking Conference
  • 4pm: Fed’s Powell Speaks in Washington

DB's Jim Reid concludes the overnight wrap

Like the weather it continues to be a year of conflicts. The global economy is fine but the weakest links are being punished in a way they weren’t in recent years (e.g. EM and Italy) as global policy tightens. Inflation is edging higher but without a killer blow yet. Shocks keep happening but vol doesn’t stay elevated for long. US equities are around record highs but yields keep on staying in check just as they look to be breaking out on the upside of their ranges. The thing we've struggled to come to terms with this year is that we did think we’d get more shocks but we also thought we’d get higher yields. Can we get both? The answer is that we probably can but we need more evidence of inflation. The ambiguity about where inflation is heading is undoubtedly the glue holding markets together at the moment.

On that front, it was interesting yesterday to see that Amazon is to raise the minimum wage for employees in the US to $15 an hour and to £9.50 for staff in the UK with a higher rate for those in London. Amazon’s CEO Jeff Bezos said that the company had “listened to our critics” and “decided we want to lead” while encouraging others to join. To put that rate in perspective the US federal minimum wage is $7.25 however 29 US states do have requirements above that level. As we know ‘Amazonification’ has been commonly referred to as being disinflationary so signs of wage growth inflation is an interesting contrast. In the grand scheme of things this move is unlikely to move the dial much but the precedent that it sets is perhaps more important. Speaking with DB’s Matt Luzzetti yesterday he suggested that this move may only add a few bps to AHE over time but that it demonstrated how tight the labour market is. Earlier this year Walmart raised its minimum hourly wage in the US to $11, while Target has indicated that it intends to raise its own minimum wage to $15 by 2020. So it’s an interesting topic of debate ahead of Friday’s average hourly earnings report.

In markets, Amazon’s share price bounced between gains and losses yesterday but ultimately closed -1.65% post that news. Broader US equity markets were once again characterised by small cap underperformance however. Indeed, the Russell 2000 closed -1.01% compared to +0.46% gains for the DOW, which closed at a new all-time high. That means the Russell 2000 has now lost -2.39% in the last 2 sessions compared to a +1.19% gain for the DOW. That differential over two consecutive sessions is the most since August 2011. The S&P 500 came within 10pts of a new all-time high, but pared its gains to close -0.04% after Fed Chair Powell gave a bullish speech on the economic outlook (more below).

Prior to this in Europe the STOXX 600 had ended -0.52%. It had looked like Italian equities might be in for another day of sharp under-performance following the price action in the first hour of the session yesterday but in the end they largely closed off the lows. The FTSE MIB (-0.23%) actually outperformed most European bourses while Italian Banks (-1.17%) pared back losses of as much as -4.09% at one stage, though they remain -13.2% lower over the last week after 5 straight sessions of losses.

The same stabilisation couldn’t be said for BTPs however with 2y (+16.4bps) and 10y (+15.4bps) yields selling off and the latter at the highs for the session and the highest level since early 2014. The 10y BTP-Bund spread also widened another 20.2bps yesterday (Bunds finished -5.0bps) which takes the three-day move to a fairly eye watering 67bps. At 302bps it’s also now eclipsed the May and August closing wides and so putting it at levels last seen in June 2013. The saving grace for now is that 2yr yields at 1.454% (+71bps over 3 days) remain comfortably below May’s peak of 2.766%. It’s hard to remember now that they were -0.33% in early May.

Driving the early price action yesterday was Head of the Lower House Budget Committee Claudio Borghi saying in the morning that Italy would have solved its fiscal problems if it had its own currency and that the government would have declared a 3.1% budget deficit for next year if it had wanted to confront the EU. He later softened his tone by confirming that there is no plan for Italy to leave the euro, regardless of his personal conviction. Deputy PM Luigi Di Maio also added to the early headlines by saying that the government would not retreat from the 2019 budget by even a “millimetre”. It’s worth noting however that overnight Corriere della Sera has reported that Italy’s draft budget plan will pledge to cut the deficit to 2% in 2021, after initially suggesting the deficit would be 2.4% for the three years up to and including then. As you’ll see shortly that’s helped to lift the euro overnight. Meanwhile on the European side yesterday, European Commission VP Valdis Dombrovskis reiterated similar comments made by his counterparts by saying that Italy’s deficit plans go “substantially beyond” the rules, while the ECB’s Olli Rehn said that the plan poses a “serious concern”. The ECB’s Francois Villeroy de Galhau also confirmed that the ECB would resist fiscal dominance and not alter course to accommodate highly indebted nations. This wasn’t a great surprise. As you’ll see in the day ahead Italy Finance Minister Tria is due to speak this morning so worth keeping an eye on the headlines.

Elsewhere, 10y Treasuries rallied another -2.0bps yesterday but what continues to stand out is the incredibly low volatility for Treasuries in the face of bigger moves for rates here in Europe. After falling to a YTD low on Monday the MOVE index is still only hovering above that level. Fed Chair Powell did speak late last night and largely reiterated his existing views, stressing the need for ongoing gradual rate hikes and emphasizing the importance of stable inflation expectations. However, equities retreated from their intraday highs as Powell described the economic outlook as "remarkably positive" and said that asset prices are high by historical standards. Rates and FX were little changed as Powell spoke.

Overnight sentiment in Asia has remained fairly sanguine.The Nikkei, which has been the star of the show in the region of late, is down -0.82% joining the Hang Seng (-0.52%) with markets in China and South Korea closed. The euro (+0.26%) has received a small lift from that Italy story we referenced above and is currently snapping a five-day losing streak while US equity futures are broadly flat. EM currency markets have gotten more focus overnight with the Indian Rupee (-0.65%) falling to a all-time low and the Indonesian Rupiah (-0.21%) has extended its decline to fresh 20-year lows with both under pressure from the Oil move.

Elsewhere sterling fell as much as +0.78% yesterday and is now over 2% lower from its Sep 20 peak as the newsflow continued to undermine Prime Minister May's Brexit plan, which includes regulatory checks between Northern Ireland and the UK mainland. Two key members of May's governing coalition partner spoke out against the proposal, with the DUP's leader Arlene Foster saying she opposes "any form" of border in the Irish sea. The DUP's longest-serving MP Jeffrey Donaldson said that the border issue is a "red line." Later in the day, Boris Johnson spoke at the Conservative Party conference and attacked May's Chequers proposal, though he stopped short of openly challenging her leadership. So overall, though our base case remains for a "soft" Brexit, we continue to question the ability of the government to produce a parliamentary majority in favour of such an outcome and we place the odds of a successful vote this year at 50%.

Looking at today’s calendar, this morning expect the early focus to be in emerging markets and specifically Turkey where we get the September CPI report. The consensus is for a +3.4% mom (yes mom not yoy) print however economists’ forecasts range anywhere from +1.7% to +4.1%. A reading in-line with the consensus would however push the annual rate up from +17.9% yoy to +21.1% yoy and the highest since 2003. Also due out this morning are the remaining September PMIs in Europe (services and composite readings) before we get August retail sales data for the euro area. This afternoon in the US we’ve got the September ADP reading followed closely by those September PMIs and September ISM non-manufacturing. Away from that it’s another busy day for central bank speak. The ECB’s Mersch is due to speak this morning before we hear from the Fed’s Evans, Barkin, Brainard, Mester and Powell over the course of the day. The latter is due to moderate a discussion at an Aspen Institute event. As mentioned at the top, keep an eye on those scheduled comments from Italian Finance Minister Tria this morning. Finally, UK PM Theresa May is due to deliver the closing speech at the Conservative Party conference today.