FX Daily: A Close Eye On US And Italian Politics

We're not expecting much market impact from the impeachment vote in the US, but political noise is intensifying in Italy and markets may move to price this in.

USD: Impeachment vote may have somewhat limited impact

The dollar has remained generally supported in early trading today as markets await new catalysts in the form of data releases or political developments in the US. On the latter, Vice President Mike Pence has pledged to keep working with President Trump until the end of his mandate, therefore refusing to remove Trump from office through the 25th Amendment. This means that the Democrats will have to go through Congress (the first vote in the House is due today or tomorrow) for the impeachment process. For now, markets have not shown a high sensitivity to the recent political turmoil in the US and with only eight days before Biden’s inauguration, it appears the effective implications of a successful Trump impeachment may be limited from a market perspective. Looking at the US calendar, the December NFIB Small Business Optimism will be released today and will be followed by a plethora of Federal Reserve speakers later in the day. Any policy-related comments should – in our view – go in the direction of ruling out any unwinding of monetary stimulus in the foreseeable future. With the Fed’s rate expectations at rock bottom, any further rise in US yields will remain a function of rising inflation expectations or term premium, which leaves us confident on our bearish dollar call.

EUR: Is Italian political risk creeping back?

The EUR is experiencing a lack of idiosyncratic drivers early in the week ahead of some central bank activity tomorrow (ECB President Christine Lagarde participating in a Q&A) and on Thursday (ECB minutes). Despite having been a background story so far, recent Italian political noise may intensify in the next 48 hours as former Prime Minister Matteo Renzi’s party (who holds some key parliament votes) may pull support from the government. For now, all parties appear determined to avoid early elections and seek a cabinet reshuffle instead, where Prime Minister Giuseppe Conte might also be replaced. We are inclined to rule out snap elections even if Conte’s government is brought down, but markets may move to price in this kind of risk (along with the prospect of a eurosceptic right-wing government) in the coming weeks. Any significant market reaction emerging in a widening BTP-Bund spread (currently at the lowest in five years) bears downside risks for the EUR, especially vs the Swiss franc, which has shown to be the quintessential hedge to EU political risk.

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