Daily Commentary BY THE CURVE TEAM –

Italian Concerns Go Global

30th of May, 2018

Nervousness over the deteriorating political situation spread overnight with global markets in a bit of a funk with everyone guessing just where to next. More noises from the Trump administration on another intensification of trade tariffs on China probably didn’t help either.

The mess in Italy is threatening to spill over into global markets and could even lead to the implosion of the European Union as it is known today. That is the sentiment of one of the most famous billionaire investors who aired his opinion overnight. He also has a pretty good track record so many sit up and take notice.

George Soros in a opinion piece overnight wrote that “the European Union is mired in an existential crisis,” and that “for the past decade, everything that could go wrong has gone wrong.” He suggests the European Union is unsustainable in its current form and changes need to be made to keep it together.

The uncertainty around Italy’s future within the Eurozone and its credit worthiness as a whole saw Italian bond yields surge overnight. At the same time the flight to quality saw US and German sovereign debt rally, driving a large drop in yields. The US and even our own 10 year yield are now between 35bp and 40bp off their highs from 9 trading days ago.

Not helping the situation was increased aggressive rhetoric from the Trump administration on trade tariffs with China as the US continues to fight battles on many fronts. From a big picture perspective, China is very interested in the outcome of the US – North Korea, off again on again, summit. So the sustained pressure on China on the trade front between the two could very well be linked to the strategy around the trade talks.

As I said yesterday, while most of the action is happening offshore, it has direct and indirect implications for Australia. The fortunes of our currency and yield curve can be very much influenced by offshore moves in the short run. Growing uncertainty could also impact funding markets, placing more pressure on the availability of offshore funding for local banks.

The RBA will be watching these developments closely. While what we have seen so far is unlikely to impact their outlook, how this evolves from here potentially will. Uncertainty over the outlook has already seen the market recalibrate its expectations for the cash rate with a hike now not fully priced until Q4 next year.

David Flanagan

Director - Interest Rate Markets