CROSS ASSET: Short USD Remains Most High Conviction Trade In Latest BofA Survey

Italian machinery exports to the US have been on a declining trend since the start of 2024, and this dynamic looks set to continue with higher trade barriers. The April manufacturing PMI noted that “new export orders were also down again in April, in part reflective of tariff uncertainty, but the trend of contraction also lost momentum compared to March”. Meanwhile, momentum in domestic industrial production remains subdued.

• US officials have struck a hawkish tone with respect to an EU trade deal in recent days. President Trump said on Monday that “I see that with trade to European Union is in many ways nastier than China. And we've just started with them. Oh, they'll come down a lot. You watch.  We have all the cards. They treated us very unfairly”, while Bessent noted that “I think the US and Europe [deal] may be a bit slower….my personal belief is Europe may have a collective action problem”.
• Meanwhile, the Commission has formulated a E95bln package of retaliatory measures, targeting US cars and planes amongst other products, if a deal is not reached. A reminder that E21bln of EU retaliatory measures in response to US steel and aluminium tariffs were also put on hold for 90 days on April 14.
• In an interview with the MNI Policy Team, an advisor to the Spanish government and the EC said the Commission will be more pessimistic about the outcome of trade talks with the U.S. following the conclusion of U.S.-UK and U.S.-China trade agreements. She noted that “the European institutions are worried about their shrinking leverage”.

Short-term momentum in the 10-year BTP/Bund spread unambiguously favours further narrowing. However, a continued lack of progress on US-EU trade talks and the Italian economy’s sensitivity to US and intra-Eurozone trade may limit scope for the spread to sustain moves below the psychological 100bps handle. 

• The spread has tightened another 2bps this morning to 100bps, with narrowing since April 9 coming alongside a recovery in risk sentiment spurred by US tariff moderations (most recently the temporary US-China agreement). Additionally, BTPs have benefitted from dovish signals during and after the April ECB decision.
• With the exception of Germany, the Italian economy is more reliant on industry than major Eurozone peers. In 2024, the industry share of gross value added was 19% in Italy, 16% in Spain, 14% in France and 23% in Germany.
• Italian goods exports to the US are worth approximately 3% of GDP, driven by machinery and transport equipment (1.0% GDP), miscellaneous manufactured articles (0.5% GDP; e.g. furniture, clothing and footwear etc) and pharmaceuticals (0.5% GDP).
• The first two buckets of goods are subject to the baseline 10% US tariff, which could climb back up to 20% if no trade deal is struck by July. Pharmaceuticals are currently exempt from reciprocal tariffs but are still at risk of sectoral levies as high as 25%. Meanwhile, sector-specific tariffs on autos (25%) and steel/aluminium (25%) will have a non-negligible - but smaller - impact. 

J.P.Morgan recommend adding longs in U.S. 10Yx20Y inflation swaps.

• They observe that “breakevens across the curve remain somewhat cheap relative to the shape of the money market curve and broad commodity prices”.
• J.P.Morgan think that the long end of the curve in particular offers asymmetric upside, based on the following reasons:
• “The 5Yx5Y/10Yx20Y inflation swap curve is trading at its flattest levels of the last few months, given the recent outperformance of the belly to intermediate sectors”.
• “10Yx20Y inflation swaps have decoupled from forward nominal yields recently, with inflation swaps trading at the low end of their 18-month range, while nominal yields continue to trade near their highs”.
• “Relatedly, while the front end of the curve is likely to remain sensitive to tariff-related developments, the long end should be supported by rising term premium, especially as the market's focus shifts toward fiscal policy negotiations”.