Rallies ? Or just Dead Cat Bounces ? China and Italy ......

ref :-  "Market Forces" by Michael Mackenzie , The Financial Times, Companies and Markets

Arguably, anytime that any market has a better day after a prolonged period in a downtrend you could ask the same thing : are we just taking a breather, or is it time to reassess ? Right now though, it seems a particularly pertinent question given the geopolitical forces at play when it comes to both China and Italy, and how high the stakes are for both those countries and global investors.

Yesterday, China's CSI 300 share index , more than a bit sickly of late, had its best day for nigh on three years. At the close, it had recorded a rise of 8% since the lows set last week. Reasons to be cheerful (as the Blockheads used to sing) ? Well, that would seem to be a huge (not to mention premature) conclusion to draw at this stage. The predominant fundamentals behind the weakness in Chinese markets have been a slowing economy, and the escalating trade war with the US (which the weakening Chinese currency is not likely to improve). These are plainly NOT small issues, and not likely to go away anytime soon. Yesterday's bounce originated from plans emerging over the weekend to introduce a range of tax cuts that would be a boost to equity prices, and by talk of coordinated state-directed market buying.

The Chinese authorities are famously "hands-on" on these occasions, and no doubt we'll see them getting involved again in the future. But whether they'll be introducing measures powerful enough to counteract the bearish factors pressurising the market whilst momentum is still to the downside must be open to doubt. The CSI 300 today ? As we write, DOWN 2.66%

And Italy ? The markets there had a better time yesterday, too. The ratings agencies did not mark down Italian sovereign debt as much as had been feared  --  in other words, Italian bonds are still rated "investment-grade" (just) rather than "Junk". Given the huge extra cost of funding had they been downgraded to the latter, of course that's a good reason for markets to be relieved. The Italian 10yr bond (BTP) yield, which at one stage on Friday had traded up towards 3.80%, was nearer 3.30% on the opening yesterday (remember, yields and prices move in opposite directions, of course).

Relief may have been merited, but with the yield as we write at 3.47% plainly, investors remained unconvinced about the future for Italy and its debt, as evidenced by the Italy / Germany 10yr yield spread remaining above 300 basis points. And frankly, it's not surprising that investors want 3% more in return to buy Italian paper rather than the German equivalent when you consider what's coming up, starting today.

Italy's proposed budget incorporating a deficit-to-GDP ratio of 2.4% for 2019 is in contravention of what the EU was expecting when it agreed with the previous government that something had to be done about Italy's mountain of debt (over 130% of GDP). The government are claiming that the increased take from the growth that their expensive policies will promote will allow them to reduce that debt (where have we heard that before ?). Hardly anyone outside of the Italian government believes that such an outcome is possible, never mind likely. The EU has to respond to the budget proposal today, and they are expected to reject it and wait on an amended proposal within three weeks  --  to do anything else would be a damning sign of weakness.

Let's just say that Italy's leaders have made it very clear how lowly they rate adherence to EU regulations in comparison with measures they believe necessary for the good of the country. As we have often said, this one has a long way to run and if short relief rallies can be justified from time to time, caution still seems like the appropriate watchword.

ref :- TAIL RISK : "Twin deficits won't hit the dollar but watch weak growth", The Financial Times, Markets and Investing

Just quickly .....  Colby Smith tells us that US dollar bears reckon that they've found at least a couple reasons why the good times for the US currency should be coming to an end : in short ... the twin deficits. The US budget deficit has widened to $779 billion, and according to many that should know when President Trump's tax giveaways and military spending are taken into account it's heading to $1 trillion. Meanwhile, the Current Account deficit that so angers Mr Trump is only increased by the firming dollar.

Intuitively, one feels that such deficits must at some point undermine the currency. Actually that ain't necessarily so .... and certainly wasn't in the Reagan years in the early 1980s which in some ways ring quite a lot of bells. Then, soaring budget and current account deficits (yes, you've guessed it ..... after swingeing tax cuts) were accompanied by a dollar that increased 32% between 1981 and 1986.

The rationale ? To quote George Saravelos of Deutsche Bank : "Domestic demand picks up after fiscal stimulus (tax cuts) .... the central bank reacts by raising interest rates .... Higher rates attract capital inflows, which strengthen the exchange rate. The appreciation (of the currency) reduces net exports and thus provides the link between a growing fiscal deficit and a widening current account deficit".

Counterintuitive it might be, but there's a certain logic to it .....

*** Incidentally, talking of expanding budget deficits .... we note that on the campaign trail ahead on November's mid-term election President Trump has promised to introduce tax cuts for middle-income earners despite the fact that none of those Republicans who would be responsible for getting the bill through Congress seems to have heard of the plan. Could Mr Trump really have made such an important announcement "off the cuff" ?. Probably .... it's a blatant vote-catcher aimed at the crucial demographic who are gradually realising that despite all the fanfare the original tax package only really benefits corporations and the very wealthy. Making good on the President's promise would exacerbate the debt problem hugely, though his argument will be that the growth dividend will more than make up the cost. Don't expect the markets to share that view should it all come to pass. Actually, in one sense there's method in his actions .... if the Democrats do well and block these kinds of moves in the House, Mr Trump can lay the blame on future voter unhappiness squarely on the opposition. ***