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A bit calmer but still intense (Daily analysis 30.05.2018)

30 May 2018 12:36|Marcin Lipka

A rebound in Italy's currencies and government bonds after yesterday's extreme volatility increase. Political parties held elections in Italy, which will be the main subject discussed by the market in the coming weeks. EUR/PLN dropped from yearly highs to around 4.32. GDP from Poland at a high level, but its components definitely failed. Surprisingly low inflation.

The most important macro data (CET - Central European Time). Surveys of macro data are based on information from Bloomberg unless noted otherwise.

  • A lack of macro data may noticeably impact the analyzed currency pairs.

Only Italy

Yesterday, all market subjects except Italy were put aside. This dramatic increase in Italian government bond yields has worsened the investor sentiment worldwide, including that of US.

The extremely nervous reaction (the debt market in Italy, the increase in the franc and the yen, the fall in the market) was caused by the fact that investors ignored the threats from Italy for a long time, believing that with favourable conditions and generally unstable political situation in Italy over the last several decades everything would somehow work out. However, the wake up from this lethargy was very brutal and affected the assets the most.

Today the situation has slightly improved. The EUR/CHF pair rebound from 1.1370 to almost 1.1500. The EUR/USD pair also appreciated strongly, amounting to the 1.1600 level. However, not everything returned to normal. Italy's government bond yields maturing in 10-year are above 3% and have not changed significantly since yesterday's closure. Taking into account that the ECB has a QE tapering and that there are negative interest rates in the single currency area, the risks assessed by the market (fiscal problems or discussion of being a part of the eurozone) are still present and are likely to persist until a political solution is found in Italy.

What will Italy do next?

Everything points to new elections in Italy. There was an idea that the Movement and the League would try to form a government again and make an agreement with the President to accept it. However, this idea is unlikely to happen because the new elections are an opportunity for the League to increase its support significantly.

Recent polls show that the League has about 25% of the votes, and in March it was only 17.4%, while the Movement remains slightly above 30%, i.e. just like in less than three months ago. However, the populist coalition has a chance to win over 55% of votes, which is significantly more than on March 4th. In addition, the League leader also believes that he has a chance to strengthen his position and perhaps become Prime Minister.

The campaign itself, however, may not be easy for populist parties. The strong fluctuations in the market in recent days could be used by the Democratic Party and Ford Italia to 'scare' people from voting for populism and from hypothetically leaving the euro area. The key issue will be whether the support for the League and the Movement will be maintained/increased in the coming days or whether it will start to decrease because the voters will start to fear for their property after the populists have taken power. This is also likely to determine the sentiment of the market. If it turns out that the support is strong, then the Movement and the League will get the "green light" to radicalise their position (not necessarily in the context of leaving the euro area, but in the context of the programme and confrontation with Brussels). It is enough for this sentiment towards the euro to remain bad for weeks to come, regardless of other market factors.

For populist parties, the campaign may not be easy. The strong fluctuations observed in the market recently may be used by the Democratic Party and Forza Italia to frighten people from voting for populists and from a hypothetical exit from the eurozone. The key issue will be whether the support for the League and the Movement will be maintained/increased in the coming days or whether it will start to drop. It may depreciate due to citizens' fear about their property being taken after the populists would win. This is also likely to determine the market's sentiment. If it turns out that the support is strong, then the Movement and the League will get the "green light" to become more radical (not necessarily in the context of leaving the eurozone, but in the context of the program and talks with Brussels). It is sufficient for this sentiment towards the euro to remain bad for weeks, regardless of other market factors.

Exaggerated GDP and low inflation

The zloty's situation was dominated by Italy yesterday. The EUR/PLN pair exceeded the 4.34 boundary and reached the highest levels in over a year. Moreover, the dollar (the high at the 3.76 PLN) and the franc (the highest rate at 3.81 PLN) appreciated. Today, the exchange rate was lower, it is not a sign of an improving condition. The situation in Italy is far from stabilising (details in the previous paragraphs) and it is difficult to expect positive information from Italy for the time being.

The GDP readings from Poland are with little importance, mainly because the publication at the level of 5.2% year-on-year for the Q1 was disrupted by a huge increase in stocks (it added to the reading as much as 1.9 percentage points). The reading without this component, which in the long run leads to zero, was at the level of 3.3% year-on-year. On the other hand, the situation in foreign trade, which has decreased as much as 1.2 percentage points from GDP, should not be expected to improve soon. Thus, there is a growing risk that the next readings will be clearly below the market expectations, especially in the context of the stock correction, which has severely overestimated the overall readings since 2016 (by 1.2 percentage points in 2016 and by 0.6 percentage points in 2017).

The Polish Central Statistical Office (GUS) published May's data on inflation, which clearly failed the estimates (1.7% YOY vs. 1.9% YOY). However, neither GDP nor inflation from Poland is currently the most important factor for the zloty. A key element is a sentiment in the eurozone and further developments in Italy. So far, these factors may have a negative impact on the Polish currency and the recent records in the euro or the franc may be exceeded again.

30 May 2018 12:36|Marcin Lipka

This commentary is not a recommendation within the meaning of Regulation of the Minister of Finance of 19 October 2005. It has been prepared for information purposes only and should not serve as a basis for making any investment decisions. Neither the author nor the publisher can be held liable for investment decisions made on the basis of information contained in this commentary. Copying or duplicating this report without acknowledgement of the source is prohibited.

See also:

29 May 2018 13:47

Panic (Daily analysis 29.05.2018)

28 May 2018 12:06

Italy’s policy (Afternoon analysis 28.05.2018)

24 May 2018 15:15

Americans on the trail of manipulated cryptocurrency prices

22 May 2018 15:24

The zloty dependent on the dollar (Afternoon analysis 22.05.2018)

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