The EC Rejects Italy's Budget Proposal. Get Ready For Ita-Leave

We expected the Forex market to consolidate this week as major stock indexes pared last week's losses and gained a level of stability.

In fact, as the G-7 equity markets drift back above last week's lowest levels, the major Forex crosses have been contained to relatively narrow ranges.

We don't see this tranquillity in the currencies lasting much longer as the simmering budget debate between Italy and the EU progresses to a full boil.

Italian budget

Italy submitted its 2019 budget draft to Brussels at the 11th hour on Monday night. EC protocol gives the Commission two weeks to either accept it or reject it; early comments from EC officials make it apparent that it won't take that long.

The point of contention is clear and simple: Italy's coalition government plans to keep their campaign promises by increasing the nation's deficit to 2.4% of GDP, which is triple the 0.8% deficit the last government agreed to with the EC and the IMF.

EC response

The EC President, Jean-Claude Juncker, was quoted yesterday as saying that Italy's budget would trigger a "violent reaction" from other Eurozone nations if it was approved in its current form and that a 2.4% deficit is not "compatible" with the EU rules.

We've seen this type of fiscal battle in the Eurozone before with Greece and to a lesser extent Portugal, Ireland and Spain. And it has always led to the Euro currency trading lower.

It's been our experience that tracking the capital flight data is an accurate gauge of how intense the internal pressure is becoming and a way for Forex traders to set up short trades in the Euro crosses.

Capital outflow

The most recent data shows that large depositors withdrew €70 billion out of Italian banks between June 1st and the end of August. We would expect this number to rise over the next few months with banks across the border in Switzerland the safest destination.

Since the capital outflow data aren't published every day, we will watch the 10-yr BTP yields as the budget standoff continues. As the depositors move money out of the country, we expect the BTP yields to rise and the Euro to fall. At this point, the spread between the BTPs and German Bunds is at a 6-year high of 330 basis points.   

Our trade suggestion on Monday to sell EUR/USD at 1.1610 was filled, which lowers our average short price to 1.1650. 

Our trade suggestion to add to short USD/JPY positions at 112.40 was filled. This lowers our average price to 113.10. 

Our suggestion to sell GBP/USD at 1.3210 was filled on Tuesday.