Italian political risks surfaced yesterday again with Berlusconi asking for a parallel Italian currency. But this is a tail risk as polls suggests that majority Italians are not in favour of an exit from the EU. Italian elections are supposed to be held before May end 2018. Italian 10 Y bond yields are at 2.1% and a break of 2.35% or 1.85% would indicate that these risks have increased substantially or have been mitigated totally. German elections are supposed to be held on 24 Sep 2017 where Merkel (euro positive) maintains a 15% lead over the second candidate.
Last year’s Jackson hole had set the tone for higher bond yields with focus on fiscal support to DM economies. The first step to this goal was stopping incremental liquidity infusion by central banks which was followed by the BOJ and ECB. The second step towards this would be reducing central bank balance sheet sizes along with increased fiscal expenditure of governments to support such economies when they cool off because of reduction in liquidity. Yellen may want to signal that balance sheet reduction and rate hikes would continue in spite of lack of price pressure so as to maintain the path towards the goal of reduced monetary stimulus, higher inflation and interest rates. I would expect USD index to bounce towards 95 levels during the next 4 days providing a good opportunity to build EURUSD longs.
USDINR 1m NDF is trading 6.5p left while KRW has appreciated to 1130 levels showing reduced NK-US risks. Indian equities are mildly in the green showing positive risk sentiments. If one were sitting on large amounts of USD to be sold against INR in this kind of environment then it would be a very uncomfortable position, and therefore I would expect that the FDI flows markets are expecting would be sold sooner than later. FPI flows continue in debt with pickup in long term category segment in August where limits are available. Nationalized banks continue to buy USDINR. CMP 64.13, Range 64.15-63.95.
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