Italian situation drives FX market
The single currency had a rough morning on Tuesday as it kept grinding lower during the Asian session and hit 1.1757 against the greenback. The upcoming Italian government is keeping investors on their toes amid promises the 5 Star Movement and the League would fight Brussels’ budget guideline, claim the control of the country’s immigration policy and ask the ECB for a debt write-off.
However, the euro and Italian equities bounced back after the populists proposed Giuseppe Conte for prime Minister. His lack of political experience, together with the fact that, if chosen, it will have to answer to both the League and the 5 Star Movement, raise concerns about the viability of such a government. EUR/USD rose 0.60% to 1.1830, while the FTSE MIB surged 0.75% to 23,270 points.
Overall, the buck has been struggling to extent gains further lately. Especially against the Swiss franc as the uncertainty generated by the Italian situation has forced investors to maintain a cautious bias. USD/CHF currently trades at around 0.9965, down 0.90% from May 10th high. However, this situation doesn’t benefit the Japanese yen that has been suffering a substantial debasement with USD/JPY rising to 111.39, thanks to the BoJ that is doomed to maintain its QE in unchanged.
Crude side of Trump
We expect oil prices to firm around $70-80 per barrel, but a geopolitical shock could send prices soaring even higher. Their march upward has been driven by global demand (China oil imports at all-time high), disruption in Nigeria and expectations of sanctions on supply from Iran and Venezuela.
Higher prices have not generated a rush of excess production from the USA. This would push prices lower, but greater domestic demand has consumed new supply (inventories remain below historical average). Oil producers are also reacting conservatively. Upstream companies have committed to shareholders to take a restrained approach by not ramping up production during temporary price volatility. This strategy in the past has been costly and ending up producing minimal additional profits but plenty of debt. We remain pessimistic that summer demand will meet market expectations. However, we are more focused on geopolitics as the prime mover for further price gains. While Iran’s output will be resilient, due to Europe unwillingness to support US actions, production will slow. Venezuelan production will continue to decline due to social disorder and the likelihood of additional Trump sanctions.
There is speculation that President Trump’s foreign policy hands are tied for fear of higher gasoline prices. We don’t see policy options as so limited. We see a clear rationale for Trump to drive prices higher: energy production is a significant Trump political base. Higher prices equates to jobs, higher wages and capital expenditures in the ‘red’ US states. Sanctions of Iran and Venezuela would also be popular with the supporters. Higher prices also will act as a tax on ‘blue’ states.