Renzi referendum fails but Euro recovers

Market Drivers December 05, 2016
EURUSD flirts with 1.0500 after Italian No, but recovers
UK PMI Services improves
Nikkei -0.82% Dax 1.70%
Oil $52/bbl
Gold $1166/oz.

Europe and Asia:
EUR Final PMI 53.8 vs. 54.1
GBP UK PMI Services 55.2 vs. 54.2
EUR Retail Sales 1.1 vs.0.8

North America
USD ISM Non Manufacturing 10:00

The EURUSD tumbled in the wake of the NO vote in the Italian Referendum on Sunday prompting the Italian PM Matteo Renzi to resign. The referendum was intended as measure to reform the Italian legislative process but came to be seen as yet another attempt by the elites to offer policy prescriptions to the electorate.

Mr. Renzi therefore fell to the same populist forces that have been sweeping Europe and North America since the summer and Italy will now have a caretaker government as the country will now likely face early elections next year. The EURUSD tumbled on the news dropping to within a few pips of the 1.0500 level at the start of Asian trade, but as the night progressed the pair recovered most of its losses and traded back at 1.0640 by mid morning European dealing.

Although the rejection of Renzi referendum dealt yet another blow to the European Union project, analysts were quick to point out that the vote today was an internal matter and Italy was in no danger of splintering from EU. Tonight's political developments however, clearly show that the populist forces that oppose further integration of the European Union are now dominating many of the region's most important economies and the next threat will now come from France where the Nationalist Front leader Marie Le Pen stands a strong chance of winning the Presidency in elections next May.

Although the EURUSD rebounded in tonight's trade in a short squeeze, it remain a sell the rally trade given the serious political problems in the region. In addition the volatile political climate may force the ECB to maintain its ultra-easy monetary policy longer than initially planned. Although there has been a modicum of improvement in EZ growth since Mr. Draghi and company instituted QE in the region, the rate of inflation is nowhere near the ECB's 2% target which suggests that the central bank can maintain its dovish stance for quite a while longer.

Such policy divergence between the ECB and the Fed is likely to put further pressure on the EURUSD and the pair could quickly return to test its recent lows at 1.0500 as the week proceeds.