EUR: too late for fruit, too soon for flowers?

“Too late for fruit, too soon for flowers” – Walter de la Mare

After the successful passage of what would, in a more normal world have been a routine finance bill in Italy, the President, Giorgio Napolitano announced that Silvio Berlusconi will step down once new austerity measures are passed. The suggestion, or growing anticipation, that the 17 year reign of Berlusconi was about to end was seen as a positive by financial markets and the EUR yesterday, however, it is not quite as straight forward as that!

Uncertainty around next steps in Italy
The fact that risk and the EUR has come back overnight is a reflection of the uncertainty that now prevails in the Italian political forum. The uncertainty centres around the next steps: will Berlusconi install the next Prime Minister instead of going to the polls early? will he choose to allow a temporary, or unity, government as an interim measure in such turbulent and difficult times?  Either way the Senate will have to vote on the austerity package on 15 November, before the lower house vote, if it is successful.

Going forward, there is by no means any guarantee that a new government will be any more successful or convincing in its ability to push through not just austerity, but the far reaching domestic structural reforms that remain central to long term prosperity. Meanwhile Investor confidence in the Italian Sovereign is sliding, causing BTP yields to come perilously close to the 7 percent level which was, among other factors, the trigger for Ireland and Portugal to seek a bailout as financing their debt became unsustainable. This morning has already seen the BTP – Bund (Italy vs. Germany 10-year bond) yield spread widen to 500bps!

Arguably the Italian situation is more of a liquidity issue than a solvency issue, however in a world where the economic fundamentals of the global economy are driven more and more by one thing – confidence – the difference between the two definitions become much more of a moot point!

Macro-economic improvements in Asia
In Asia the macro-economic backdrop improved modestly overnight, with an improvement in the Australian consumer confidence survey as the recent interest rate cut filters through into sentiment. The South Korean (valid as a barometer of non Japan Asia) unemployment rate improved to 3.1 percent in October, confounding expectations of a rise to 3.3 percent and the much awaited Chinese consumer price index confirmed that inflation moderated, as expected, in October to 5.5 percent (from 6.1 percent in September). However, ‘global’ investor confidence continues to be weighed down by the Eurozone concerns and uncertainty.

The data calendar is very light again today with nothing of great interest this afternoon. On that basis the eyes of all asset classes will likely be on BTP yields and equities as a driver of sentiment and positioning. In my mind AUD looks vulnerable to the downside today and I continue to favour GBP vs. EUR ahead of the psychologically important 0.8550 and 0.8525 levels, despite this morning's disappointing trade data.