Equity markets are flat-to-higher, while core European government bond yields have slipped lower after reports that the European Commission was considering fining Italy for breaching its debt rules; NZD is slightly lower to start the week

Markets have been quiet overnight with both the US and UK on holiday.  Equity markets are flat-to-higher, while core European government bond yields have slipped lower after reports that the European Commission was considering fining Italy for breaching its debt rules.  The NZD is slightly lower to start the week.  

There haven’t been too many new developments on the US-China trade war front.  Trump is visiting Japan at present and he told a press conference with Japanese PM Abe that, while China would like to strike a trade agreement, “we’re not ready to make a deal.”  Trump added “I think sometime in the future China and the United States will absolutely have a great trade deal, and we look forward to that.”  For now though, both sides seem reluctant to compromise and the market remains concerned that the next move in the conflict will be the US imposition of 25% tariffs on the remaining $300b of Chinese imports, with China likely to retaliate.  US equity index futures have tracked sideways since trading opened this week while most European equity indices were up around 0.5%. 

US Treasury bond futures point to a 2bp decline in the US 10 year rate, in sympathy with moves in core European bond yields.  The 10 year bund fell 3bps to -0.145, its lowest level since mid-2016 (the all-time low is -0.20%), amidst safe-haven demand.  Bloomberg reported that the European Commission was considering commencing excessive deficit proceedings against Italy, which are used when a country does not comply with European rules that restrict the deficit to 3% of GDP and show a path for debt to below 60% of GDP (Italy currently has debt-to-GDP of 132%).  If the European Commission sanctioned Italy, it could levy a fine of up to 0.2% of GDP, which is likely to enrage the anti-establishment coalition.  Italian Deputy PM, and leader of Lega Nord, Salvini showed no signs of backing down, telling reporters that the government had no intention of raising taxes to comply with the rules.  Italian government bond yields were 12bps higher on the day.  Incredibly, Italy’s 5 year yield is close to surpassing that of Greece, whose bond yields fell sharply after PM Tsipras said he would call a new general election.  The Greek opposition (and market-friendly) New Democracy party is leading in the polls. 

The increase in Italian yields, after the reports that the European Commission might fine Italy, has weighed on the euro, which is a modest 0.15% lower on the day, just below 1.12.   Movements in other currencies have been similarly restrained, given the UK and US holidays, but the common trend is a slightly stronger USD overnight; the DXY index is up 0.2% to 97.76. 

The GBP has moved lower this week, as the results from the European parliamentary elections confirmed a strong showing for Nigel Farage’s Brexit party, which topped the vote share with 32%.  European elections are not generally a good proxy for the number of seats that a party might win in a UK general election, since the latter has a first-past-the-post system and sees far greater voter turnout (for instance, UKIP received 28% share of the vote in the 2014 European elections but won only a single seat in parliament in the 2015 general election).  That said, Conservative leadership hopefuls have pounced on the election result, in which the party received less than 10% of the vote, as suggesting that the electorate wants Brexit to be delivered (ignoring the fact that parties that support a second referendum received a combined 41% of the vote in the European election).  The likelihood is that most leadership candidates will campaign to take the UK out of the EU without a deal unless the EU makes substantial concessions, in order to appeal to the mainly Eurosceptic party membership which will decide the next leader.  This makes new elections a growing risk.  If the new Conservative leader makes it clear they are willing to leave without a deal, there are likely to be sufficient numbers of moderate Conservative MPs who are willing to abstain in a vote of no confidence in the government, as Chancellor Hammond hinted at over the weekend.  The GBP is likely to remain volatile for the coming months. 

The NZD and AUD have drifted lower to start the week amidst a backdrop of a stronger USD.  The NZD is trading at 0.6540, 0.2% lower from Friday night’s close.  NZ rates stabilised yesterday, after the sharp falls last week, with swap rates around 1bp higher across the curve. 

Over the weekend, RBNZ Deputy Governor Bascand gave an interview to the AFR on the topic of the bank capital review.  Bascand said the RBNZ was “open minded” about modifying the proposals, including the amount of extra capital banks would need to hold, the length of the implementation period, and whether hybrid debt could be used to meet the capital requirements.  He noted that the RBNZ was firmly of the view that banks needed to hold more capital, but his comments signalled a greater openness to considering changes to the proposal.  The RBNZ expects to make a final decision in November, but the Bank may provide some further clues about its thinking at the Financial Stability Report on Wednesday. 

It’s another quiet session ahead data-wise, with only US and European confidence numbers released. 

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