Until Italy’s political situation stabilizes, it is too early to hope for EUR/USD price rise

Fear makes the wolf bigger than he is. People are likely to overestimate the results of certain events. I must admit, I, on the contrary, underestimated the scale of Italian political crisis. Italy-German 10-year yield spread has widened to 2.7%, from 2.4%, sending EUR/USD down. The situation has been fueled by a decline in the euro-area core inflation to 0.9%. Despite an increase in consumer prices by 2.1%, the main driver has been an increase in energy prices by 9.5% Y-o-Y, while domestic demand in the euro area is still low.

Will president Mattarella interfere in the government’s policy? Will the Italian Finance Minister Giovanni Tria quit? Will S&P Global Investors and Moody's revise Italy’s rating? There are enough questions to create tensions in the market and encourage the foreigners to sell Italian securities. The most sensitive one is whether Italy’s turmoil will spread to the other Eurozone countries. Won’t Greece, Portugal and the others be willing to focus on economic expansion, rather than on the policy of fiscal consolidation? If it is so, euro’s viability will be discussed in the markets again.

The political crisis in Italy is not the only bearish driver for EUR/USD. The derivative market suggests only 5-percent chance that the Fed will increase the rate 4 times in 2019. If the U.S. inflation continues to speed up, the U.S. unemployment is further decreasing, and the U.S. GDP rate will be going up at the same pace, the Fed will have to tighten its monetary policy aggressively. Can one suggest that the factor has been already included into the USD rate and won’t support it in future? The ECB, on the contrary, will by any means discourage the euro bulls, putting off the monetary normalization. And the reasons are not in the core inflation alone. The current account surplus is increasing rather fast in the euro-area, driving the single European currency up. The cheap money policy is the only means to weaken the euro and support exporters at the same time.

Dynamics of EUR/USD and the Eurozone current accounts

Source: Bloomberg 

I can’t say that the greenback is perfect. Despite the USD 5-percent rise in the second quarter, the share of the U.S. dollar in global reserves has been down to 62.3%, from 62.5%. It has been down for the ninth time during the past 10 quarters; and the process can well accelerate as there are no improvements in the U.S. trade relations; and Donald Trump’s protectionism makes other countries diversify their FX reserves in favor of other currencies.

Dynamics of the U.S. dollar share in global reserves

Source: Bloomberg

As I had expected, the first storm of the zone $1.156-$1.159 failed; however, it is still too early to suggest that the euro has touched its bottom. The turmoil in Italian markets hasn’t been eased, and the Euro-area core inflation leaves much to be desired. The battle is going on; however, if EUR/USD bears manage to break out the support at 1.1525-1.153, the euro will be more likely to continue sliding down towards 1.1415 and 1.136

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Price chart of EURUSD in real time mode

Euro Slipping on Policy

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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