June 5, 2019 / 7:41 AM / 3 months ago

Daily Briefing: Brussels takes on Italian debt mountain

LONDON (Reuters) - Today the European Commission will announce whether it will launch disciplinary proceedings against Italy over its debt-laden public finances, with the prospect of hefty fines if it does not agree to comply with European Union budget rules.

Italy's La Repubblica quoted this morning from what it said was a draft of a Commission letter to be sent to Rome, stating that Rome's fiscal policies lack prudence and could expose the nation to a shock loss of market confidence.

Threatening to resign this week, PM Giuseppe Conte called on Italy's coalition to respect EU budget rules and warned of the disastrous fallout from a loss of market confidence, but the senior coalition partner, the League rejects the logic of those rules and wants to push ahead with tax cuts that would add to the deficit in the short term.

Barring an upset, Danish voters look set to hand power to the country's Social Democrats in today's general election. The campaign has revolved largely around two issues: welfare spending and immigration.

The Social Democrats have captured the mood of “enough is enough” among many Danes who feel that years of austerity have undermined the country’s Nordic model of high-quality welfare - and appear ready to pay to defend it.

More cynically, the centre-left party has also adopted the tougher anti-immigration stance of the far-right Danish People’s Party (DF). The DF as a party are expected to fare poorly in the poll - but, like populists in other European countries, they will have the satisfaction of knowing they have set much of the political agenda.

The last day of U.S. President Donald Trump's state visit to the UK will be spent with other world leaders on the coast of southern England marking the 75th anniversary of D-Day, the seaborne invasion that helped bring World War Two to an end.

U.S. President Donald Trump and Prime Minister Theresa May speak at a dinner hosted by himself and first lady Melania Trump at Winfield House in London, June 4, 2019

PM Theresa May and her government will probably heave a sigh of relief when he flies off to Ireland after the ceremony: Trump was remarkably on-message about Brexit, trade and Huawei at yesterday's main press conference and even came back to correct himself on a stray comment about the NHS being "on the table" in any negotiations (it wasn't clear whether he had understood the reporter's question in the first place). All that can be overturned by a stray tweet, of course.


The real significance of Federal Reserve Chair Jerome Powell’s largely anodyne speech on Tuesday was that he pointedly didn’t protest the market's reappraisal in the past week of the U.S. interest rate trajectory.

Powell said the Fed would act as “appropriate” to deal with any impact on the U.S. economy from rising trade tensions and dropped the word “patient” from his phrasing on when the central bank would make its next change of policy.

In effect, he endorsed the seismic shift in rates and futures markets, which now see up to three rate cuts this year, possibly starting as early as July. That was enough to lift the gloom that had descended on Wall Street, catapulting the S&P500 up more than 2%, above its 200-day moving average and recording the biggest one-day gain since early January.

The ViX “fear gauge” of implied U.S. equity volatility dropped almost two points to below 17%. Whether a policy volte face from the Fed at this point is enough to stave off recession is another question, but the recent history of downturns show the Fed has typically been pre-emptive enough to get its first rate cut in before any two-quarter contraction that defines recession.

Although 10-year U.S. Treasury yields bounced modestly on the stock market rally and Powell speech , they fell again early on Wednesday and have lost almost 50 basis points in just over a month.

The inversion of the yield curve that’s seen 10-year yields fall below 3 months equivalents, a widely watched warning sign for a future recession, has deepened further to 27 basis points and close to its most negative since before the last downturn in 2007.

The Fed rethink weakened the dollar’s DXY index for the fifth straight day to its lowest in seven weeks, while safety plays saw Japan’s yen outperform once again and euro/dollar nudge higher to 1.1265.

But global recession fears and the Fed's shift are sweeping across the world. Sub-zero German 10-year government bond yields fell to a record low of minus 0.2250% first thing on Wednesday, with speculation the European Central Bank meeting tomorrow will match Fed dovishness and possibly announce looser terms for a new cheap lending scheme, or TLTROs.

Ten-year Japanese government bond yields, meantime, fell below minus 0.115% to their lowest since August 2016. After a strong rally on Tuesday, European stock futures were steady to higher, with S&P500 futures up slightly, too.

In Asia overnight, Tokyo’s Nikkei climbed almost 2%, - although Shanghai, Hong Kong and Seoul all underperformed with smaller gains. China’s offshore yuan was a fraction weaker, though emerging-market currency and equity indices continued to benefit from the Fed speculation and dollar retreat.

China's services activity climbed at its slowest pace in three months in May, a private survey showed. In the first face-to-face discussion between key U.S. and Chinese trade negotiators in nearly a month, U.S. Treasury Secretary Steven Mnuchin is scheduled to meet with People's Bank of China Governor Yi Gang this weekend at a gathering of G20 finance leaders in Japan.

In Europe, Italy’s sovereign debt yields fell, in line with Germany, after its ruling coalition partners committed to holding the government together despite speculation about a snap election later this year.

The European Commission is due on Wednesday to make a decision on the next steps in its standoff with Rome over breaking EU budget rules, with the Italian press reporting it will warn Italy about a loss of market confidence if it does not rein in deficit projections.

The ruling League’s economics chief, Claudio Borghi, told Reuters the government should not back down in the row with Brussels. Sterling was a touch higher against a generally weaker dollar after U.S. President Donald Trump held out the chances for U.S./UK trade deal post-Brexit.

— A look at the day ahead from European Economics and Politics Editor Mark John and EMEA markets editor Mike Dolan. The views expressed are their own —

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