Euro zone Political Developments Remain Front and Center

BBH CurrencyView

• European shares have given back early morning gains as Berlusconi denies resignation reports
• Market attention will remain focused on political developments in the euro zone; Italy likely to overshadow Greece now
• Light US data is likely to see the market focus on Fed speakers; China CPI highlights EM data

European stocks got a boost from early session lows amid hopes of a Berlusconi resignation (though these reports have been denied). There are nevertheless signs that the new coalition government in Greece is helping restore some market confidence but the focus remains on Italy. As a result, most European shares are lower, with European banking shares down 0.1%. The cautious shift in market sentiment offset the much weaker than expect EZ retail sales and a slump in German industrial output. Bunds remains bid, with the Italian-German spread reaching new record highs ahead of Italy’s confidence vote tomorrow. A sharp drop in Swiss inflation reinforced talks of further SNB action.

Attention this week will remain focused on political developments in the euro zone. While Greece dominated the headlines last week, we suspect that looking ahead Italian politics and funding concerns are likely to become the concern for market, given the 10-year off the run Italian yield is now at 6.637%. Nonetheless, Greek PM Papandreou agreed to step down to allow the creation of a unity government, which will lead Greece to elections immediately after the implementation of decisions made at the EU summit meeting. This would likely dash fears of a disorderly default and reduces market anxieties about the release of the next aid tranche. Italy could be an even bigger worry though, with tomorrow’s vote of no confidence on the implementation of austerity measures potentially leading to a collapse of the government. In fact, new reports have indicated that Berlusconi may resign his post today. Further Italian political paralysis is likely to be viewed negatively for the market and in turn could further widen Italy’s yield spread to Germany. Financial market stress is likely to weigh on the economy amid the sharp increase in borrowing costs. Recall, Italy’s October mfg. PMI at 43.3 shows the Italian economy is likely to enter a recession soon, if not already in one. As a result, our bias is to expect the euro to weaken from here with the downside cross of the 5 and 20dma likely to add momentum to the move. We expect support near 1.3650, and see near term resistance near 1.3850. Also of note is that CAD’s 5 and 20dma just crossed as well.

With macro data light on the calendar we suspect that many will be keen to focus on Fed speakers, with Bernanke, Yellen, Tarullo, Evans, Plosser and Kocherlakota slated to speak. Markets will be on the lookout for any further indications that more easing would be considered, even thought we suspect hints on this seem unlikely this week given the recent batch of strong economic data. We continue to expect the next move for the Fed is likely a change in its communication style, rather than expanding its balance sheet under QE3. The BoE also meets this week but given the announcement of renewed asset purchases at last month’s meeting, we doubt the BoE is likely to bring forward any new announcements at this juncture. Still, the outlook for the economy continues to deteriorate and we suspect that markets are keen to focus on November 16’s inflation report (although today’s housing number were good). Elsewhere, Australia’s jobs report is also likely to be market moving, with a rise in the unemployment rate likely to be supportive of another rate cut. While we continue to expect that external factors are more likely to drive AUD for now,weakening economic data, together with the increasing chance of rate cut at the 12/05 meeting, is likely to weigh on AUD.

Trade numbers from Taiwan overnight came in better than expected with exports and imports rising substantially in October. Exports to the US and intra-Asia were especially strong, but were lower to several European countries. Recall that the last Korean trade figures surprised on the downside, rising at the slowest pace in 2 years, which followed lower-than-expected trade numbers in Hong Kong, Singapore and China. Aside from Indonesia where trade numbers have remained strong, we have been a little concerned about a slowdown in trade in the region. Data remains mixed and inconclusive in our view, but Taiwan’s numbers today do offer a bit of relief. On Wednesday, Russia releases trade numbers, we get CPI from Mexico, IP from South Africa, and China releases CPI, PPI, IP and retail sales. Also, the Polish central bank meets and we expect it to keep rates unchanged at 4.5%. On Thursday, Philippines and China release trade data, Brazil releases retail sales and the SARB is expected to keep rates on hold at 5.5%. On Friday, the BoK and the central bank of Malaysia will likely keep rates on hold at 3.25% and 3.0%, respectively. We also get IP numbers from India, Turkey and Mexico as well as inflation numbers from Hungary, India and Brazil.