The tempest

The Italian political crisis turned out to be a storm in an espresso cup.

Damaging policies dreamed up by the right-wing/left-wing coalition sent Italian debt yields upward at a gallop. Then the President vetoed prospective Cabinet members and yields really took off. The two-year government bond got as high as 2.70% last week; it was -0.25% just three weeks ago. This morning, that had calmed right down to about 0.72%.

So investors were at first scared of a broad coalition of Italian radicals, then more scared that  it didn’t get to appoint the people it wanted, then they were terrified that a safe pair of hands was offered up. Once the spendthrift policies were back on the table, markets then became pretty benign about the world’s second-most indebted developed nation. What does this tell us? Markets are batty? Perhaps the most enlightening aspect of this episode is the edginess of investors. A whole bunch of bondholders appear to have had their eyes on the door and they dashed for it at the first sign of trouble. These were some astonishing moves in little more than a week.
There are a few good reasons for this nervousness. Large swathes of Italian sovereign debt is owned by retail investors and the prospect of them taking big losses on their safest investments is worrying for the economy, Italians and their politics. Also, most Italian banks, weak as they are, hold much of their regulatory capital in Italian debt. That means a collapse in bond prices could trigger a banking crisis as well.

Of course, last week’s moves will have been intensified by trend-following algorithmic trading and stop-loss programs. Volatility, when it comes, is flurried, fevered even. And traders seem to care more about change than about fundamentals – you can almost see the binary code on the tape.

Meanwhile, Spanish Prime Minister Mariano Rajoy lost a confidence vote called after his party was embroiled in an historic campaign slush fund scandal. Mr Rajoy’s successor is Socialist Party leader and economist Pedro Sanchez, who is now trying to consolidate a rag-tag bag of small opposition parties into a functioning government. If he fails to bind the gamut of conflicting parties, Spain will probably be heading back to the polls later this year. Spanish two-year debt yield jumped significantly as Mr Rajoy departed, but quickly recovered most of its ground. Still, the short-term debt remained in negative territory, it briefly hit 0% before dropping back to -0.22%.

With the European Central Bank laying so much buying pressure on Continental bonds, we believe the euro is the best barometer of foreign capital’s view on the EU and its prospects. The currency market is just way too large for the central bank to have any effect so we think it offers a more helpful picture. The trade-weighted euro took a 3% dip in May after 10 months of reasonably constant value.
We think more turmoil could be bubbling under the surface of European debt markets.

Populism isn’t popular

What Donald Trump giveth, he also taketh away.

For months now, trying to keep track of US trade and foreign policy has been like counting cats on a merry-go-round. Negotiations between China and America have dragged on for weeks, tariffs have been implemented by both sides while the talking continues. Metal tariffs are to be levied on Europe, Canada and Mexico after all – apparently even allies are getting in the way of America regaining its greatness. The peace summit with North Korea is on or off depending on how often you refresh your Twitter feed. Mr Trump is soon to sit down with Vladimir Putin, President of a nation that almost certainly meddled with the US election and which stands on the other side of the war in Syria. Of course, Syria and Russia are allies of Iran, a nation that Mr Trump despises. And then there are the recent Israeli overtures to Russia, again, an enemy of Iran trying to cosy up to one of its allies. Perhaps there is a concerted effort to turn Russia against Iran. Who knows, nothing seems to make sense.

If the US-Russia summit does happen, expect a chorus of concern, rumour and conspiracy from Democrats about the two men’s relationship. There is no lack of evidence of improper involvement with Russia by Mr Trump’s inner circle. A summit could be a good way for Russia and the US to defuse the tension that has steadily grown between them. But given the context, any conciliation can only seem suspicious, warranted or not.

As for Mr Trump’s trade pronouncements, hitting your own allies with hefty tariffs seems dangerous. Not only has this angered Canadians, Mexicans and Europeans alike, it has ratchetted up the cost of aluminium and steel in America. Considering the US is crying out for a bout of infrastructure spending – one of Mr Trump’s most popular campaign platforms – making raw materials significantly more expensive is probably not the best strategy.

It’s not just steel, either. International carmakers slumped (and US ones jumped) after the President unveiled a “national security” investigation into foreign competitors and parts suppliers. More 25% tariffs could be in the works. The last time US car companies were protected by the state, they got complacent and made terribly inefficient cars that cost too much. Again, the move hurts US allies: Japan and South Korea aren’t exactly being rewarded for their diplomatic and military assistance against North Korean aggression. And Germany gets slapped with stiff levies on one of its most important exports.

Are these moves a political ploy to bolster support in the rust belt ahead of the mid-term elections in November? Is Mr Trump burning foreign friends to boost his popularity at home? If so, it may not work: according to recent polls most Americans believe protectionism is a bad idea. However, a decent majority of Republicans are behind greater tariffs. It may be that the President is aiming at a certain kind of voter that could be crucial in the upcoming hustings.

Or maybe Mr Trump simply doesn’t like BMW cars …

Bonds

UK 10-Year yield @ 1.28%
US 10-Year yield @ 2.90%
Germany 10-Year yield @ 0.38%
Italy 10-Year yield @ 2.66% 
Spain 10-Year yield @ 1.43%
 

Economic data and companies reporting for week commencing 4 June

Monday 4 June

UK: PMI Construction
US: Factory Orders, Durable Goods Orders
EU: Producer Price Index

Final results: GB Group

Tuesday 5 June

UK: PMI Services
US: PMI Composite, PMI Services, ISM Non-Manufacturing
EU: PMI Composite, PMI Services, Retail Sales; GER: PMI Services, PMI Composite

Final results: Altitude Group, AO World, DiscoverIE Group

Wednesday 6 June

UK: Halifax House Price Index 
US: MBA Mortgage Applications, Trade Balance
EU: Factory Orders, Eurozone Retail PMI; GER: GDP, Construction PMI, 

Final results: RPC Group, Workspace Group
Trading update: WH Smith

Thursday 7 June

US: Continuing Claims, Initial Jobless Claims, Consumer Credit
EU: Household Consumption; GDP GER: Industrial Production

Final results: Auto Trader Group, CMC Markets, Mitie Group

Friday 8 June 

UK: Bank of England/TNS Inflation Attitudes Survey
US: Wholesales Inventories
EU: Labour Costs; GER: Balance of Trade, Current Account