USD, Euro and the Risk of Italeave

USD is about flat for the year – but has strengthened over the last five weeks as Treasury yields and the forward funds rate have backed up. But USD was weak early in the year, during larger back-ups. Large pair-wise moves against USD have been event driven, especially EUR, which faces the tail-risk of break-up if the new coalition government in Italy tries to exit. A break-up of the common currency, or even the threat of it which would drive a run-on-the-bank across Europe, would be a catastrophic systemic event. Italy’s coalition may not last very long, and it faces high hurdles to euro exit, but could court disaster with the proposed halfway-measure of circulating “mini-BOTs” as a parallel currency. Italy is highly indebted, but has a low deficit and has been fiscally stable for two decades. Its problem is growth, and we don’t rule out that the coalition’s proposal for massive tax cuts and tax simplification could set better growth in motion.