Funda-FX Wrap: Italy is spreading a virus throughout global markets

• Markets are starting to wake up to systemic risks.
• Euro got clobbered as the worst G10 performer while the yen was the best performer.
• Italy and European politics driving risk-off sentiment.
• US financials beat up on banking concerns due to the Italian political virus.

Funda-FX today was lively, stimulating the downside in markets and yields and subsequently supporting the Japanese currency along with the safe haven asset classes with investors diving for cover on Tuesday as the markets were starting to wake up to systemic risks.

The key driver of the downside was that reflation trade unwinding yet again with the bears peeling rubber off the euro crosses as Europe crumbles to the floor while Italian and Spanish political contagion developments pull the eurozone project and single currency into question yet again, leaving the euro hanging out to dry.

The latest deadlock in Rome is regarded by the markets as the biggest crisis in the eurozone since Greece last threatened to leave in 2015.  Italy is a much larger economy than Greece though - as the third largest country in the eurozone project, pro-euro campaigners/advocates fear that if the nation were to exit the euro, it could indeed be game over for the single currency. However, the contagion risk is more to do with Italy’s sovereign debt pile of €2.3 trillion.

Italy has the heaviest debt pile of the eurozone and should the nation pull out of the project and effectively default such borrowing, the ramifications to global markets would be catastrophic. This all brings back memories when Draghi, the governor of the ECB,  announced he would do “whatever it takes” to stop a break up happening, unveiling that emergency programme of backstop bond buying by the ECB.

While France's Macron's antipopulist vote may have ringfenced the European Union for a moment,  it appears not be as fortified as first glance may have presumed with the north/south divide becoming even more apparent when Germany's EU commissioner Oettinger, said today that the market will teach the Italians to vote for the right thing.

Italy’s infuriated League, who questioned whether Italy is still a democracy, and 5S, whose leader, Luigi Di Maio, had called for Mattarella’s impeachment, are now considering a joint campaign after refusing to offer a different choice of finance minister, thus prompting the breakdown of the coalition.

Trade war spat heating up again

Meanwhile, across the pond, the trade spat between Washington and Bejing was revived by the latest comments from Trump. The President of the United States has been ramping up tensions yet again ahead of the next round of trade negotiations that will take place as soon as this weekend when US Commerce Secretary Wilbur Ross will visit China.

Firstly, Trump had already announced a national security investigation into imports of cars and trucks, a probe that was expected to lead to tariffs against China as well as against Germany, Canada, Japan and Mexico. But, then, just today Trump said he’s moving ahead with plans to impose tariffs on $50 billion of Chinese imports - Trump is also seeking to curb investment in sensitive technology, ratcheting up pressure on Beijing.

At the same time, however, while the dollar catches a bid on risk of portfolio flows, futures now only see a 50% chance of third 2018 Fed hike.

Key Global market reactions

European equities finished up as follows:

• Italy's FTSE MIB is down -2.65%
• Portugal's PSI20 is down -2.58%
• German Dax is down -1.6%
• France's Cac is down -1.4%
• UKs FTSE is down -1.2%
• Spain's Ibex is down -2.2%

As far as safer government bets went, there were massive pain trades in fixed income and the European 10 year yields were showing where the money flowed as follows, (German, UK and France notes collected the bids while money flew out of Italy, Portugal and Spain):

• Germany 0.272%, - 7.3 bps
• France 0.658%, -4.1 bps
• UK 1.215%, -10.7 bps
• Spain 1.651%, +12.7 bps
• Portugal 2.2%, up 12.9 bps
• Italy, 3.174%, up 49 bps

US markets followed suit. The DJIA closed down -391 points or 1.58% at 24361. The low reached 24247.  The S&P fell -31.47 points or -1.16% at 2689.86 and the Nasdaq fell -37.26 points or -0.50% at 7396.59.

• 2 year 2.399%, down 7.6 bps
• 5 year 2.657%, down -10.7 bps
• 10 year 2.824%, down 10.7 bps
• 30 year 3.001%, down 9.10%. The low traded to 2.983%

Key funda-headlines:​​​

• Trump has loaded up on fresh amo in the cold trade war on Tuesday
• S&P Corelogic Case-Shiller Index: Home prices not slowing down
• US: Conference Board Consumer Confidence Index improves to 128 in May from 125.6 in April
• Dallas Fed: Texas manufacturing expansion accelerates notably
• Italy's PM-designate has left presidential palace without comment - Reuters
• Fed's Discount Rates Minutes: Directors remained positive about prospects for economic growth
• Italy's PM-designate considering giving up mandate - ANSA
• SNB's Jordan: Developments in recent days show currency market situation remains fragile
• Ecuador OilMin: OPEC should maintain output cuts at next meeting
• Mexico's Diaz de Leon: Peso reflecting broadly stronger USD, uncertainty about NAFTA and election
• DBRS Credit Ratings: Italy's debt situation "still manageable"
• Turkey is ready to hike rates if May inflation rises