Morning comment: Italy & Brexit

Chris Scicluna
Mantas Vanagas

Another poor session on Wall Street saw the S&P500 post a further 1.8% loss yesterday, extending its decline since early October to almost 10%. Technology stocks remained subject to particular heavy selling pressure. However, the largest losses were seen in the energy sector as crude oil slumped as much as 6% to levels not seen since October last year (Brent falling below $62/bbl at one stage). The risk-off tone led to only a very modest decline in the 10-year Treasury yield, which is now sitting at sitting at 3.08%, and a further slight decline in market inflation expectations as measured by break-evens rates on TIPS (10Y break-evens now at 1.98%). Meanwhile, the US dollar had a strong day, especially relative to commodity-sensitive currencies.

After the New York close the office of the US Trade Representative released a report stating, amongst other things, that “China fundamentally has not altered its acts, policies, and practices related to technology transfer, intellectual property, and innovation, and indeed appears to have taken further unreasonable actions in recent months,”. Even so, and notwithstanding the background provided by Wall Street’s losses, the Chinese equity market erased a weak start to leave the CSI300 up 0.25% at the close, with the Hang Seng 0.5% higher. Bourses elsewhere in Asia generally closed in the red, although losses were much smaller than might have been expected. In Japan, the TOPIX fell just 0.6%, cushioned by a weaker yen. The more positive mood has extended to Europe this morning, with most bourses opening higher.  

Looking ahead, Italy’s dispute with the EU and Brexit will both be firmly in the spotlight today, with the Commission publishing its opinion on the revised Italian budget plans, and May and Juncker meeting in Brussels in the early evening. On the former, reports of a possible further shift in Italian policy is benefiting BTPs this morning, while progress seems likely on the latter to keep the EU-UK on track for a deal to be sealed at Sunday’s special summit. Attention would then shift, of course, to the UK Parliament, where the arithmetic remains finely balanced, but some Tory Brexiters do appear now to be looking for an excuse not to reject May’s deal.

The only report issued in Japan today was the All Industry Activity Index for September, holding less interest than usual given that the first estimates of Q3 GDP growth have already been released. For the record, the index fell 0.9%M/M – in line with market expectations – and was down 1.1%Y/Y. As already published, industrial production fell 0.4%M/M and tertiary activity fell 1.1%M/M. As usual, the new data in this release concerned the construction sector, where output fell 0.4%M/M and 2.5%Y/Y.  For Q3 as a whole the All Industry Index fell 0.7%Q/Q, erasing most of the 0.8%Q/Q gain in Q2. Construction activity fell 2.3%Q/Q, tertiary sector activity fell 0.4%Q/Q and IP was down 1.5%Q/Q. These data, of course, were significantly impacted by typhoon and earthquake activity, and we expect a rebound in all three sectors in Q4.

Euro area:
Today is set to be uneventful on the euro area data-front.  But the European Commission is set to publish its opinions on the member states’ budgetary plans, including the revised Italian document submitted last week. On this, the Commission is likely to reiterate its previous criticisms, noting again that the budgetary plan represents a ‘significant deviation’ from what was required under the EU rules, meriting the launch of a formal Excessive Deficit Procedure against Italy. Nevertheless, having risen yesterday back to within a whisker of the post-election peaks, BTP spreads have narrowed significantly this morning (10Y spread currently down more than 10bps) on reports that the Italian government might be ready to make further amendments to its plans. E.g. One report suggests that League leader and Deputy PM Salvini is considering reducing the amount of public expenditure to be allocated for the (Five Star Movement’s flagship) citizen’s income policy and for reversal of past pension reforms. We shall see – we note that the League’s poll ratings have continued to benefit from the confrontation with Brussels, and suspect that any amendments to the plans will be more cosmetic than substantive. (In the markets, Germany will sell 5Y Bunds.)

The Brexit negotiations restart this evening at the highest level with PM May flying to Brussels for talks with Commission President Juncker seeking to reach agreement on the draft political declaration accompanying the withdrawal Agreement ahead of Sunday’s special summit. There remain a number of points to finesse, on a range of issues from fisheries and Gibraltar. Meanwhile, reports suggest that many Conservative Brexiters want to reheat May’s earlier (and, unsurprisingly, previously rejected) proposals on investigating technological solutions to achieve a frictionless Irish border without recourse to the currently drafted backstop. No doubt fully aware that such technology is unlikely to be feasible, more than anything these reports seem to suggest that many Brexiters are looking for an excuse not to reject the final draft Withdrawal Agreement if and when Parliament votes on it next month. The government’s decision last night to accept opposition amendments on the draft Finance Bill to avoid risking defeat in formal votes (probably deliberately) highlighted its parliamentary weakness ahead of next month’s crucial Brexit vote, likely adding to the pressure on some Brexiter MPs from their constituency chairs to back (or at least refrain from voting against) the PM.    

Meanwhile, data-wise, the October public finances figures are due today. So far this year, borrowing has significantly undershot expectations, providing the room for the Chancellor room to loosen fiscal policy next fiscal year, as long as a no-deal Brexit can be avoided. Today’s data should maintain the positive trend.

Today in the US brings further data from the housing market – which is showing signs of a loss of momentum across a range of indicators, as perhaps might have been expected following steady increases in mortgage rates – with October’s existing home sales figures due. Durable goods orders for the same month are also scheduled for release – with the headline figure expected to report a notable decline on the back of soft order flows for commercial jets and bookings for defence aircraft – alongside the Conference Board’s Leading index and the final reading of the University of Michigan’s consumer sentiment survey for November. In addition, the weekly jobless claims figures have been brought forward to today ahead of the Thanksgiving Holiday. And, against the backdrop of the recent marked drop in oil prices, the Baker rig count has similarly been brought forward today for release along with the usual EIA oil data. Supply-wise, the US Treasury will sell 10Y TIPS.

Another quiet day in Australia saw just the release the Department of Employment internet’s job vacancies index for October. The trend index fell 0.5%M/M – a seventh consecutive decline – reducing annual growth to an almost 2-year low of 0.7%Y/Y. This is consistent with other hiring indicators which are generally off their peaks, while still suggesting that ongoing employment growth remains likely.

New Zealand:
The latest GDT dairy auction resulted in a further and disappointing 3.5% decline in average product prices – a 12th consecutive decline. The average price for whole milk powder – of greatest importance to New Zealand – fell 1.8% to the lowest level in more than 2 years. While the recent decline reflects news of a very good start to the New Zealand dairy season – milk volumes rising 6.5%Y/Y in October – the longer-running trend decline in prices provides some offset to the generally better-than-expected news flow in recent months.


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