Focus: Elections in Italy, tensions on FX markets

Decision on new elections in Italy

Lega leader Salvini's doubts about the continued existence of the governing coalition were followed by Prime Minister Conte's announcement that he would convene parliament next week to ask for a vote of confidence. Early elections have therefore become very likely in Italy. President Mattarella has already expressed his preference for a date in October.

Although the political crisis has been looming for some time, the markets reacted strongly to the foreseeable end of the current government. The yield premium of 10Y Italian government bonds over German bonds temporarily widened by over 30 basis points. The markets are worried, as a change of government increases the uncertainty about Italy's future fiscal policy. More important for the markets, however, is that, according to current polls, a coalition of right-wing parties (Lega, Forward Italy, Brothers of Italy) can be expected as a result of the elections. This outlook naturally raises questions about Italy's future relationship with the EU. From today's perspective, we do not expect a future Italian government to seriously question its relationship with the EU or its membership in the Eurozone. The consequences of such a step would be too far-reaching and too negative for Italy. However, the coming months will probably be marked by the election campaign and corresponding EU-critical statements. The uncertainty on the markets will therefore remain high for the time being. October thus promises to be a turbulent month, as the decision on Brexit is then also due.

Uncertainty on currency markets on the rise

This week began turbulently, with the yuan weakening against the dollar. The movement itself was not strong. However, for the first time since 2008, the dollar crossed seven yuan, which was seen as a sign by the markets. The Chinese central bank denied any instrumentalization of the exchange rate. However, this did not convince the markets, as only a few days earlier President Trump had announced an increase in customs duties for Chinese imports as of September 1. Rather, the markets saw the weakening of the yuan as a warning shot from the Chinese side and a worsening of the trade conflict, which it was.

However, the concerns of the markets are likely going beyond this. As a result of the escalation of the conflict between the US and China, and the resulting probable global economic slowdown, there could be a global currency war. This means that countries/currency areas would try to weaken their currencies in order to gain an export advantage. This "war" can be fought either through verbal intervention or physical intervention through the sale of one's own currency. US President Trump has repeatedly accused both the Europeans and Chinese of keeping their currencies artificially low, but without providing any evidence. Moreover, according to media reports, physical currency interventions in the markets have already been discussed within the US government, but a decision was taken against such moves. However, there is more to this than the dollar-yuan exchange rate. With the Swiss franc, too, an intervention by the Swiss National Bank is certainly in the offing in the event of further strengthening. At the SNB, however, this would not be unusual, as it has repeatedly resorted to this instrument in recent years. But this does contribute to the global mood. Surprising rate cuts in New Zealand, India and Thailand in recent weeks have also been taken by the markets as indications of a possible global currency war.

The question as to how things will continue depends not least on how the conflict between the US and China develops, but above all on how badly the global economy will suffer as a result. Things are not looking good at the moment. The yuan has weakened further (slightly) against the dollar over the course of the week. The mood between the negotiating parties seems to be at a low and if the situation does not escalate further, it would already be good. Further verbal interventions to weaken the dollar are likely, but this has also happened several times in recent months. The markets will pay attention to whether the tone becomes rougher and whether a physical intervention in the markets is thus in preparation. Essentially, all this means that currency markets will in future be determined to a lesser extent by economic data and the interest rate outlook, but will increasingly become "political" markets. This would generally increase volatility and uncertainty in the markets. The markets have already developed to some extent in this direction. We are not currently assuming any physical intervention on the part of the US. Too much is at stake here. This would undermine the agreement among the G-20 countries not to use competitive devaluations. However, the tone could become rougher, which would also have an impact on the EURUSD.

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