Back to that trade spat

Summary

Concerns on Italy stayed on the back burner during the first half of Europe's cash equity session. This widened focus back out to the likely impact of the increasingly fractious U.S.-China trade dispute ahead Friday payrolls data that will be critical for the dollar.

Milan shines

Milan’s FTSE MIB was up almost a percentage point as investors sought out further bargains following a 13% decline between 7-29 May. The Italian index outshone fair gains by London’s FTSE 100 and indices in Paris, Madrid, Lisbon, and Zurich. Germany’s index was among exceptions, on the back foot partly due to the euro’s bounce.  The single currency’s recent drubbing provided underlying support for Europe’s robust exporters, including giant carmakers like VW, Daimler and BMW. These auto names were a drag on Thursday, on reports the White House was turning anti-trade ire on German luxury car imports. Still, so far, the global trading day has supported a revival of risk appetite, with easing tensions across debt and equity markets lifting MSCI's 14-country Asia Pacific index up 0.6% from Wednesday's two-month low, and Japan's Nikkei up 0.8%.

China snaps after U.S. threat

China was both a source of firmer sentiment and again a key component of the main sticking point that has dragged global shares for six months. In a sudden change of tack, the world’s second-largest economy adopted a more aggressive tone on trade matters, saying it said it would take “resolute and resourceful” measures in the event of “arbitrary and reckless” acts by the U.S. The comments were made in response to the White House noting it might still deploy threatened tariffs on $50bn in Chinese imports. U.S. officials arrived in Beijing on Wednesday for talks ahead of a visit by Commerce Secretary Wilbur Ross on 2-4 June. Whilst there are no signs talks could be cancelled, investors are likely to keep chalking up pre-summit spats as part of the negotiation process. Additionally, the slow burning U.S.-China conflict has done little harm to China’s export-led manufacturing base, which grew at the fastest pace in 8 months during May, above forecasts. Scepticism that such strength is sustainable is brewing though.

Patience in Italy

Correctly, or not, the lack of news from Italy was interpreted as good news. Attempts to rekindle government-forming efforts remained protracted. The leader of one half of the would-be coalition, the Northern League’s Matteo Salvini, said he would “seriously consider” an offer from his 5-Star counterpart, Luigi Di Maio to restart talks. A private meeting has been reported. A fresh election could be avoided. Both head of state and interim PM have signalled willingness to allow the parties more time to reach agreement. In turn, 5-Star/League have dropped a contentious nomination for economy minister. The atmosphere of compromise has increased the market’s patience, and reduced alarm. Realistically, risk aversion could return in a flash if the nascent government returns to confrontational rhetoric on the euro or policies that could widen Italy’s 132% debt/GDP ratio.

Euro resilient like data

The euro as a proxy of Europe-predicated risk has been appropriately resilient against the backdrop of the rebound in that region’s markets. Trading 19 pips higher at $1.1681 at the time of writing, it had in fact drifted off a high of $1.1724, bested by resistance observed at $1.1715. Still, the ECB’s path to an end of QE this year is clearer after firmer than forecast inflation data around the region this week, including from Italy. European PMI data out on Thursday also backed signs of resilience, reducing concerns over faltering economic readings from the last few months.

An ex-rally theme for the dollar was also evident in sterling. GBP/USD’s break above $1.33 now looks clean. The level was crystal clear resistance in September and November and support just before the pound catapulted to post-referendum highs earlier this year. A daily close above $1.33 would go a long way to improving sterling’s upside prospects. The first in a coming stream of UK PMI releases on Friday will help point the way for sterling.

Against the yen, dollar trading was more ambivalent. Japan’s currency was on the back foot against sterling, though slightly to the better side of the greenback. However, signs that the bias was still lower for USD/JPY included that its bounce earlier this week stalled on Wednesday at 109.82. The dollar is still set for a second weekly decline vs. the yen.

Fed inflation gauge focus

With holidays having messed up the usual pre-payrolls release agenda, customary ISM data that typically precede the U.S.’s monthly employment report have been delayed. The Institute for Supply Management’s manufacturing index will follow Friday’s NFP release, whilst the ISM’s service sector gauge will be out next week. That leaves the remaining watch for Thursday on a deeper dive into Wednesday’s weak quarterly Personal Consumption Expenditure print. The key Core PCE index is forecast to fall in line with the broader snapshot by ticking down to 0.1% growth for April, from 0.2% in March.