FX Currents: The Italian Crisis

Last week, you read my views on Brexit. So far we are on track with how Brexit will unravel. It’s been reported that in early December, we’ll have the House of Commons vote. I’m convinced we’ll see the current deal rejected.

We should then see the EU and GBP head south. The EURUSD started the move Friday evening, and I expect it to continue.

But, the effects of Brexit will pale when compared with what may happen once the Italian crisis explodes.

Let’s have a look at the context.

Italy’s debt is 132% of its GDP (twice that allowed by EU rules).  The huge bill has been partially blamed by on the double-dip recession Italy finds itself in. In turn, the recession has been blamed on EU imposed austerity.  The current expansionary budget breaches EU rules, and the EU has told Italy it has to change it. The latter has told the EU that it will stand firm.

That’s the context. Here’s the problem…..

If the confrontation spikes bond yields, Italy may well have to default on its sovereign debt. That would impact European banks holding Italian bonds raising the spectre of contagion.  It’s important to appreciate that Italy’s debts are too big to rescue. If push comes to shove, Italy may leave the Euro (and return to the lira). Such a move would trigger another crisis.

The EU has postponed action against Italy until 2019. So far the market has reacted as though the crisis will be resolved. Hmmm, we’ll see.

I don’t see the Italian Government backing down. If so, the EU is caught between the devil and the deep blue sea. If it does nothing, other countries will be encouraged to breach EU rules; if it seeks to enforce, it runs the risk of contagion. I see the latter occurring.

Now the technicals need only support this analysis – could well set me (and you) up for a fab 2019!  As usual, I am merely expressing a personal view – not to be taken as financial advice.