Orange alert for Italian markets

The red alert on Italian capital markets has been stood down, though with another weekend of uncertainty ahead as the new coalition inches towards formation of a complete government, market participants were opting for safety. The coalition continues to emit a stream of uneasy headlines – e.g. possible exclusion of investment spending from the budget deficit. As such, Italian assets will probably remain on edge well into next week at least. The FTSE MIB rose for two sessions this week before plunging to a fresh one-month low on Friday, dragged by domestically exposed banks and utilities. But the spread between benchmark BTP and bund yields is contained. It is still slightly narrower than end-2017 with bund yields rising faster than the BTP’s. All in, market conditions are debilitating in Italy and may persist for some time, though volatility is unwinding.

Elsewhere, the week in global equities shows post-February correction trends intact. The FTSE and Germany’s DAX have ground about 1% higher in four sessions vs. U.S. counterparts like S&P 500, which retreated. Much Wall Street attrition took place in second halves of New York sessions, as on Thursday. On Friday, S&P 500, Dow and Nasdaq index futures sparkled again. This cycle could go on for some time. A strengthening economy means only creeping stock market erosion instead of intermittent collapses in response to yield stress.

Meanwhile, conditions for Treasurys remain punishing, pointing to further yield elevation to challenge U.S. shares. Thursday’s weak TIPS auction, which saw the highest yields since January 2011, will be followed next week by further huge supply. This week has also seen fracturing technical levels across the term structure, opening the way to more hotly anticipated milestones on the upside (talk of 3.25% on 10-year yields is growing).

Under these conditions, the dollar’s ascent has some way to run. It is still punishing the euro, setting the single currency on course for a fifth straight weekly decline. The trend of new euro lows has stalled for now. Sellers were hanging back from structural support near $1.1715/20 on Friday, August 2015’s high and last December’s low.

In sterling, the customs union story keeps giving—and taking away floors for the pound. Latest anonymous reports suggest Downing Street is examining a backstop plan applying EU’s external tariffs beyond 2020. News has kept cable jammed in a $1.3456-$1.3606 range this week . It was last towards the lower end around $1.3494. 200-day moving average support was lost on Thursday. A lower close for the week beckons. It would almost certainly extend sterling’s decline into a sixth week.

Higher U.S. yields keep the yen under pressure too, with help from Nikkei’s 13% rise since March. The dollar against the yen will soon face a resistance cluster between 111.17-48, 17^th-23^rd January highs. But USD/JPY broke above 110.85 this week, the 61.8% Fibonacci retracement marker of November-March’s 114.73-104.56 slide. The downside is supported.

The robust dollar has created a generous ceiling for European equity prices (apart from Italy). True, European shares were on the backfoot on Friday, partly consolidating three sessions of gains that took STOXX to a three-month high. Benchmark European yields also tilt higher, like the U.S., but the differential is key for stocks.

Further potential oil inflection points are among the items to watch for later Friday, chiefly U.S. rig count data, though in recent weeks these have been neutral. Prices remain supported by a billion barrels of crude removed from supply since OPEC began cuts. Brent last traded at $79.75, though traders were girding for another look at $80 after Thursday brought the first since 2014. Saudi Arabia continues to insist it won’t step into the shortfall from newly sanctioned Iran, whilst Venezuela’s constraints curtail output to near 70-year lows. Shale economics are taking a turn for the worst, hence helping remove more supply than forecast earlier in year.