The political developments in 2016 have certainly caused their fair share of turbulence and market volatility, which for the moment show no signs of stopping.
The latest event was the "NO" vote regarding the Italian constitutional amendment in the national referendum that took place on 4 December 2016.
The strong market movements open doors for larger price swings and potential trading opportunities.
This article will explain the economic and political developments and review the recent price action following the Italian referendum 2016. It also offers our approach to tackling the markets in the upcoming days and weeks.
Consequences of the Italian referendum 2016
Image by Bloomberg
The referendum that occurred in Italy on Sunday, 4 December, is an event of similar magnitude. It determined whether the government should accept ("YES" vote) or reject ("NO" vote) proposed amendments to the Constitution.
This political event proved nerve-wracking for the European Union, although the "NO" vote ultimately prevailed, collecting approximately 59.1% of the votes (40.9% voted in favour of the reform).
Prime Minister Renzi even staked his political career on the vote, expecting a favourable outcome. The gambit failed and Renzi announced his resignation soon after the result became clear.
The aftermath of this political chess game remains open, although Italian President Sergio Mattarella could still choose a new prime minister, or decide to hold early elections. The latter option may create a new political landscape, possibly resulting in the rise of the populist political party known as 5 Star Movement, and clearing the way for a referendum on the Euro currency and EU membership—popularly labelled "Italexit".
Italy will certainly not be the only country hogging the limelight in 2017, as France, Germany and the Netherlands are also expected to hold elections. France will host presidential and legislative elections, Germany will offer presidential and parliamentary elections and the Netherlands will see a general election take place.
As a result of these events, 2017 could see a continuation of the political upsets that took the world by surprise this year, although the exact political developments, and their repercussions, remain to be seen.
Market volatility during major events
The financial markets saw a "YES" vote in the referendum as a building block for supporting the ailing Italian banks, who have been haunted by under-performing loans and require recapitalisation to avoid a negative spiral.
The victorious "NO" vote will heighten concerns regarding the Italian banks and may lead to downgrades from rating agencies in the future.
For the moment, the key concern is whether any delays will emerge in the recapitalisation program aimed at the Italian banks, towards a consolidation of the Italian banking system (mergers of small and mid-sized banks).
The European Central Bank (ECB) is expected to react on Thursday, 8 December, during the ECB press conference and explain whether it will extend its bond-buying program from March 2017 onwards. Be sure to check your Volatility Protection Settings and be ready for abnormal market reaction.
The ECB has already increased its purchases of Italian government bonds in the short term to stabilise the bond market.
Since Italy's "NO" vote in the constitutional referendum, the chances have risen that the ECB will announce a continuation of its quantitative easing (QE) program to contain the market pressures on Italian debt. The current expenses of the program are at 80 billion euros per month, with 52 of the 60 economists expecting a six-month continuation.
The EUR/USD initially took a nose dive as soon as it became clear that the "NO" vote would emerge victorious. In fact, the market showed a bearish gap at first. However, this was short-lived when price tested the 1.0450—1.05 support zone from the weekly charts dating back to March and November 2015.
The EUR/USD bullish rally recovered strongly, as expected in our wave analysis, and eventually even broke above 1.07 in intraday trading.
This indicates that the "NO" vote had been largely priced into the markets beforehand.
Obviously, the "NO" vote was, for the most part, already priced into the market. As we can see, the EUR/USD went exactly according to our prediction.
So, what now?
First and foremost, we need to focus on the ECB press conference on Thursday, 6 December. If the ECB is unable to come to the table with more QE, we could see the bounce move in the Euro extend.
This is not yet Italy's Brexit and a high level of market volatility is likely to follow the vote. The president has 70 days to form a new government and those days are certain to be turbulent.
Technically, the EUR/USD has a room for the upside. 1.0750 is the next resistance, but if it fails, we could see 1.0816—1.0830, with bears possibly reversing the price. Even better if it happens around Thursday since traders might short into rally on the dovish ECB presser.
Within the POC zone (50.0, H5, bearish order block), we might see a rejection towards 1.0680 and 1.0630.
The German DAX index has reversed heavily from L3 monthly camarilla levels and at this point it shows a giant inverted head and shoulders pattern. After the initial drop, it traded higher on Monday and recovered from early losses.
Any spike above 10770 could target 10831. Daily close above it targets 11040. If we want to see a reversal, the DAX should drop below 10400—a strong support, with 10185 as the final target.
Cheers and safe trading,
Nenad and Chris