USD buoyed as risk sentiment deteriorates
The greenback rose across the board on Wednesday morning amid general increase in nervousness to Italy’s future government. The dollar index surged to 93.975, up 0.35% on the day, as the euro dipped to 1.1711 (-0.57%), the pound sterling slid to 1.3385 (-0.35%), while the loonie gave up 0.50% with USD/CAD increasing to 1.2882. On the other hand, safe haven currencies were better bid this morning as both the Japanese yen and the Swiss franc extended gains. USD/CHF slid as low as 0.9895, while USD/JPY returned towards 110.
Market participants are still waiting for Italian President Sergio Mattarella to approve Giuseppe Conte as prime minister. The Italian President still hasn’t taken his decision suggests that he is not entirely convinced Conte would fit the job. It may sound as a good thing for investors as one may assume that if Mattarella refuses to appoint Conte, the 5-Star Movement and the League would have to propose someone with an actual political base and a stronger political background. Indeed, Conte is mostly unknown, has no political experience and is therefore unpredictable – and as you know markets like predictability.
We remain cautious regarding a potential pull back of the market against such a backdrop. Indeed, the 5-Star and the League won’t give up their program should Conte be turned aside. This period of uncertainty could last more than a few, especially if they want to get their hands dirty as soon as possible, starting with their campaign promises: slashing taxes, boost spending, roll back pension control immigration and ask for a debt write-off.
JPY continues to gain on risk aversion trading. UISDJPY has fallen sharply to 109.90 from 110.95 on persistence selling pressure. Outside of the obviously macro environment risk which are generally “media-cycle” led suggesting short-term volatility and swings, there is the weak Japan economic fundamentals. Recent inflation slowdown is clearly disappointing for the BoJ and continues to present a significant challenge for the central bank. Japanese core inflation is well below 1% which is the lowest in the G10. Even the weaker JPY is unlikely to generate meaningful inflation forcing the BoJ to lowers is inflations forecast again. Barring a momentous economic acceleration or positive inflation shock, it’s unlikely that the BoJ will meet its 2% target. We continue to see the BoJ moving away from stick adherence to monetary policy steering within Abenomics. The BoJ appears to surrendered on reaching its inflation target. The closer we move toward the BoJ end-game the more market will be pricing in a strong JPY. Deceleration of BoJ focus on normalizations and lagging EUR suggest a constructive trade on long EURJPY.