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2 Political Crises Gripping the Globe

2 Political Crises Gripping the Globe

Boris Schlossberg, Technical Strategist

In Italy, the full-on resignation of Berlusconi’s PDL party could topple the country’s coalition government, while across the Atlantic, a shutdown of the US government is looming just hours away.

It has been a cautious opening to this week's trade, as political crises on both sides of the Atlantic are weighing on the US dollar (USD) and euro (EUR), while the other G-10 currencies sway back and forth.

In Italy, the wholesale resignation of Silvio Berlusconi’s People of Freedom (PDL) party threw Prime Minister Enrico Letta's government into a lurch by threatening to topple the fragile governing coalition. Letta said that he would request a confidence vote on October 2 in order to preserve his ruling majority as he scrambled to find support among the individual legislators of the PDL. Letta needs 24 votes to secure a new majority, and he is unlikely to find support from Beppe Grillo's Five-Star Movement, which is the main opposition party in Italy’s Parliament.

The turmoil in Italy has taken its toll on the country's sovereign bond market, and the Italian/German bond spread widened to nearly 280 basis points. Prime Minister Letta may still be able to avoid snap elections, but until the situation is resolved, the pressure on Italy's sovereign debt is likely to remain, and that should keep EURUSD contained below the recent highs at 1.3570.

The fresh political tension in Italy, along with lack of any resolution from the German elections one full week later, could put fresh pressure on the European Central Bank (ECB) to act. Today's Eurozone CPI data, which printed at 1.1% versus 1.3% expected, indicates that there is absolutely no threat of inflation in the region, which would allow monetary policymakers to ease conditions further if they so choose.

In recent public appearances, ECB President Mario Draghi has signaled that the central bank is willing to consider a rate cut as well as new rounds of LTRO, and if the political situation in the Eurozone does not improve, he may resort to both tactics at this week's monthly ECB meeting.

US Government Shutdown Looming

Meanwhile, across the Atlantic, all signs point to a shutdown of the US government as House Republicans continue to link the Affordable Care Act to funding the US budget. Barring any last-minute compromise, it appears that the US government may close many non-essential operations tonight. Aside from the heavy political and economic costs that such a move would entail, it may also leave capital markets in the dark.

This is the week that markets were to get a look at last month's labor data in order to determine the likelihood of tapering by the Federal Reserve. However, if the Bureau of Labor Statistics (BLS) is furloughed, this week’s most important economic data may not be released, only adding to the confusion in the markets.

With turmoil in DC showing no signs of resolution, it is becoming more evident by the hour that the Fed may not consider tapering until the end of the year, at the earliest. That, in turn, is likely to put fresh downward pressure on USDJPY, especially if the ISM data misses its mark this week. The pair had been trading below 98.00 for most of the overnight session, and could test support at 97.50 if the Chicago PMI report due at 13:45 GMT (9:45 am ET) today disappoints the market.

By Boris Schlossberg of BK Asset Management

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.