The Week Ahead: Italian referendum has the ECB on alert


A government mandate forces Italian pollsters to stop their work two weeks preceding the Italian vote on constitutional reforms, reducing the anxiety about the No result. Italians headed to the polls on Sunday, December 4 and while the referendum is not about a potential Italexit (Italeave?) it could mark the beginning of the end for Italy’ membership in the European Union.

Prime Minister Mateo Renzi did at one point pledge to step down if and when the reforms were voted down. The lack of a functioning government would put even more pressure on the already distressed Italian financial institutions. A flight to safety following the No win and a Renzi resignation would likely push higher the cost of borrowing and beyond what the Bank of Italy could face in a short window without the support of the European Central Bank (ECB).

The ECB will have a busy week starting with the aftermath of the Italian referendum and when it releases its final monetary policy statement of the year. The central bank will release its statement on Thursday, December 8 at 7:45 am EST. The ECB is expected to extend the term of its bond purchases by 9 months until the end of 2017 and change the limits on what type of bonds it can purchase in order to expand the pool of available assets. The EUR has been stable ahead of the Italian referendum and ECB statement even as the Fed rate hike on December 14 puts pressure on the single currency. The credibility of the ECB has been questioned in the past and this time there is little room for changes to an already massive quantitative easing program and the central bank will also be rated by the market on how it handles the outcome of the Italian referendum.

Favorable economic conditions for Europe
The EUR/USD gained 0.538 percent in the last week. The all mighty U.S. jobs report was solid, but did not change the landscape for the U.S. Federal Reserve’ rate hike in December. The U.S. economy added 178,000 jobs in November.

In Europe economic conditions have been favorable as noted by MarketPulse’ Kenny Fisher:

“Eurozone indicators were solid on Thursday. German and Eurozone manufacturing reports indicate expansion in the manufacturing sector, and the unemployment rate dropped to 9.8%, its lowest level since December 2011. On the inflation front, Eurozone CPI Flash Estimate continued to rise, gaining 0.6% in November. This is a significant improvement from the first half of the year, when this inflation index posted four consecutive declines. Still, inflation remains well below the ECB target of 2.0%, despite record low interest rates pegged at 0.00%. Earlier this week, Draghi said that the Eurozone growth had been “moderate but steady” despite the effects of global economic and political uncertainty. Draghi also said that he expected the economy’s recovery to continue.”

The EUR will fluctuate in the Italian results. The ECB will be on call to deal with any pressures to the liquidity of Italian banks, but given the political resistance of an outright bailout it will use emergency funds if needed. The decisions on Thursday will also be limited by a political framework as certain members have blocked the expansion of the QE program and the possibility of the funds being used to bail out non-performing credit institutions. this leaved the central bank with few options that could have a meaningful impact, but at least the ECB can go into Thursday with the high probability of an interest rate hike by the Fed a week later which reduces the burden on the European central bank.

The state of the OPEC agreement
The price of energy surged 8.33 percent this week. West Texas is trading at $50.75 in the aftermath of a surprise Organization of the Petroleum Exporting Countries (OPEC) production cut agreement at the group’ meeting in Vienna. The shock came for the fact that after working on a similar deal since March of this year, the agreement has faced several public failures when it was only a freeze of production. The production cut was announced in Algiers to some surprise as even limiting output had proven so hard, a cut seemed too optimistic. Meetings ahead of the November 30 meeting did nothing but increase doubts as comments from Iran and Iraq showed them offside of the rest of the OPEC.

In Vienna Saudi Arabia stepped up to absorb a bigger share of the production curb, but also managed to get Iran to reduce their output. Non-OPEC member Russia also agreed to participate with other major producers seemingly onboard as well. The challenges for energy producers will become how to monitor this new agreement and avoid overproduction. The higher prices are a boon for U.S. shale producers that at one point targeted by OPEC to be run out of business, are now one of the biggest beneficiaries of the Vienna production agreement.

Correlation between the Loonie and crude
The USD/CAD lost 1.565 percent in the past five days. The Canadian dollar has risen against the USD thanks to the effect the OPEC agreement had on energy prices. The high correlation between the loonie and crude has the currency trading at 1.3283 after touching three week lows in the aftermath of the production cut announcement. Canadian economic fundamentals have been mixed as the bulk of the economy has been dragged down by lower natural resource prices. Canadian employment surprised with 10,000 new positions added on a forecast of a loss of 17,000. The unemployment rate was lowered to 6.8 percent, but it does bear mention that those gains were mostly part time positions in the service sector and the participation rate fell to 65.6 percent.

Next week the Bank of Canada (BoC) is expected to keep rates unchanged and will mark a whole year the central bank stood in the sidelines after a proactive 2015 that included two rate cuts. The Canadian benchmark rate stands at 0.50 percent and with little room to cut it is close to resorting to more unconventional tools. Governor Stephen Poloz has not given any specific details on the monetary policy strategy for next year, but the market is aware the Canadian economy is heavily dependent on its U.S. counterpart as long as president-elect Trump does not modify that relationship as he intended to do on the campaign trail.

The Canadian government did make the BoC burden easier this year by announcing a fiscal stimulus package. While not accomplishing all of its goals it did show a willingness to spend in order to create jobs, but it was deemed too small to make a big difference. The U.S. is now about to embark in a fiscal stimulus push that could stoke American inflation and require the Fed to raise rates multiple times in 2017. The BoC will have to be aware of the growing interest rate divergence and what if any advantage a weak loonie has brought to the Canadian economy.

Market events to watch this week:

Sunday, December 4
All Day EUR Italian Constitution Amendment Vote

Monday, December 5
4:30am GBP Services PMI
10:00am USD ISM Non-Manufacturing PMI
10:30pm AUD Cash Rate
10:30pm AUD RBA Rate Statement

Tuesday, December 6
8:30am CAD Trade Balance
5:00pm NZD RBNZ Gov Wheeler Speaks
7:30pm AUD GDP q/q

Wednesday, December 7
4:30am GBP Manufacturing Production m/m
10:00am CAD BOC Rate Statement
10:00am CAD Overnight Rate
10:30am USD Crude Oil Inventories

Thursday, December 8
7:45am EUR Minimum Bid Rate
8:30am EUR ECB Press Conference
8:30am USD Unemployment Claims

Friday, December 9
10:00am USD Prelim UoM Consumer Sentiment

*All times EDT
For a complete list of scheduled events in the forex market visit the MarketPulse Economic Calendar