Market Shrugs Off Latest US Tariff Provocation

With the changes in the German auto sector, of course, Draghi is likely correct that some of the slowdown in the EMU is temporary, but there is something more sinister likely taking place.  The ECB introduced a negative deposit rate in June 2014 and began buying government bonds nine months later. And yet even yesterday, Draghi is beseeching countries to adopt structural reforms that will boost the growth potential. Many economists look at a country like Italy with high levels of unemployment as argue that Italy cannot possibly be operating at capacity. However, if structural obstacles exist that prevent people from securing jobs or freeing up capital from non-profitable businesses or rules that favor rent seekers then assessing capacity requires more than simply looking at unused factors of production.  

As we noted yesterday, one way the Italian government can show a smaller deficit without backtracking on its campaign promises is to delay the start of some new initiatives, like the Citizen's Income. Also, who can qualify for the rolling back of pension reforms could also be tightened on the margins. This may save a couple tenths of a percent and some press reports suggest that Italy may be headed in this direction. However, the EC is expected to push back still. It wants the deficit to be no more than 2% of GDP, and the government's forecast is based on optimistic projections of growth.  Separately, note that the European Court of Human Rights is set to rule on whether Berlusconi can run for office again. If he can, the thinking is that later next year, perhaps after the spring election for the European Parliament, League leader Salvini will precipitate a political crisis and team up with a more natural and traditional ally, Berlusconi for a center-right government.  

The euro reached almost $1.1475 last week. Today it successfully tested $1.1300 support. The narrowing of the Italian premium over German does not appear to have helped the single currency as it has in the recent past. On the other hand, maybe it has, and euro would be lower, given the macro considerations, which include the disappointing flash PMI and the decline in short-term yields reflected in the rally in Euribor futures. There is 920 mln euro option struck at $1.13 that expires today and about 2.85 bln euros in options between $1.1400 and $1.1415 that will also be cut today. Sterling has slipped below last week's shelf near $1.2760. Support is seen in the $1.2700-20 area, with a little more than GBP300 mln option at the lower end that will be cut today. It takes a move above $1.28 to lift the tone.  

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Marc Chandler 6 months ago Author's comment

Yes. Thank you. Deflation in goods and maybe not all goods but some. Not services, and as you know American households spend more on services than goods. Also, if inflation/deflation refers to general price levels, the idea that US auto sector has excess capacity could be expressed as a relative price change rather than general price change.

Kurt Benson 6 months ago Member's comment

Nicely done.

Gary Anderson 6 months ago Contributor's comment

With capacity utilization under 80, to say the US has excess capacity is a warning of deflation, Marc.