USD Index, EURUSD and GBP Strength

USD: USD to stay bid today The outcome of the Italian referendum has been so far specifically EUR negative, with limited negative spill-over effects into wider FX markets. USD/JPY, the proxy for the global risk aversion, is largely flat while EM Asia currencies are only modestly down. Should the ECB extend its QE programme by two more quarters at the current EUR80bn pace (ie, no tapering) on Thursday, this should further limit negative spill over effects into broader FX markets. USD to remain bid today, particularly if we see solid November ISM Non-manufacturing.

EUR: Not an ideal outcome, yet still too early to price in the worse case Although the No vote in the Italia referendum was expected, the wider than expected margin between the two camps (60% for the No vote) disappointed markets. Looking ahead, the focus is on two factors in terms of EUR price action: (a) the prospects of a new “political” government vs. early elections (b) the re-capitalization of Italian banks. At this point, we think (b) will have a larger bearing on EUR then (a). Despite the No vote, this still does not mean a material change of the government (towards the anti-establishment parties) or an imminent early election. A new PD led government may still be on cards (though under a different PM) hence it is still too early to price in the worst case political outcome. Rather, the focus turns to the planned EUR5bn recapitalisation of Monte dei Paschi bank. If the current recapitalisation plan fails, this may rise concerns about the wider Italian banking sector and thus have a larger bearing on EUR then politics. Unless the latter factor gains in importance EUR/USD should still remain above last year’s low of 1.0460 for now.

GBP: Benefiting from EUR’s woes As has been the case since the US election, GBP benefits against EUR during bad EUR days. At this point, market appears to consider GBP as a relative safe have. Today’s UK Nov PMI Services are expected to held up and EUR/GBP should remain in the 0.8300-0.8400 range today