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Currencies: German Election Outcome To Erode Euro Positive Momentum


Sunrise Market Commentary

  • Rates: Short term Bund gains after German elections?
    German elections ended with a Pyrrhic victory for Merkel’s CDU/CSU and create some uncertainty. The SPD’s voluntary move to the opposition paves the way for a coalition with Liberals and Greens, but is maybe less “European friendly”. Peripheral spread widening could be the result today, while the Bund could eke out some short term gains.
  • Currencies: German election outcome to erode euro positive momentum
    Last week, USD softness prevailed. The German election outcome dominates headlines this morning and is considered as less EU friendly. This weighs on the single currency. Sterling was sold after a Moody’s downgrade late on Friday’, but the UK currency shows resilience as the dollar and the euro trade soft this morning.

The Sunrise Headlines

  • US equities ended Friday’s dull sideways session virtually unchanged. Asian equities, excluding Japanese ones, trade down in the opening session.
  • German chancellor Merkel gained a 4th term but her party’s result was the worst since 1949. A far-right party entered parliament in a sign of the growing polarization. Social democrats refuse to hold coalition talks, so Merkel will have to forge an agreement with the Liberals and Greens, creating uncertainty.
  • A Republican attempt to repeal and replace Obamacare appeared headed for defeat after senator Collins said she doesn’t see herself backing the plan and Senator Cruz said he’s currently “not a yes.” However, uncertainty remains.
  • Moody’s cut the UK Aa1 rating to Aa2, outlook stable. The outlook for public finances has "weakened significantly," with fiscal consolidation plans in question and debt burden expected to continue to rise, Moody’s justified. It may hit sterling, as Fitch and S&P have a negative outlook on their UK rating.
  • Republican tax negotiators are targeting a corporate tax rate of 20%, according to people familiar with the matter. That would be higher than President Donald Trump wants — setting up a key decision for the president.
  • New Zealand PM English has claimed a mandate to form the next government after winning the biggest slice of the vote in Saturday’s election, even as opposition leader Ardern refuses to concede defeat. NZD/USD trades lower.
  • The Republicans cemented control over the French Senate, a setback for president Macron. However, it has only limited powers and its composition reflects the 2015 municipal elections (municipal councillors elect Senate).
  • Today, attention goes to the IFO survey and manifold central bank speakers.

Currencies: German Election Outcome To Erode Euro Positive Momentum

German election to weigh on the euro ?

Sentiment on the dollar remained fragile on Friday as (geopolitical) uncertainty and a cautious risk-off mood deprived the dollar of highly needed interest rate support. The euro was supported by strong EMU PMI’s. However, at the end of the day, the moves were modest. EUR/USD closed the day at 1.1951. USD/JPY finished the week at 111.99.

There are several stories to guide trading at the start of the new week. Japanese equities outperform as markets look out for new pro-growth measures as PM Abe is considering snap elections for next month. USD/JPY trades again in the 112.25 area, but is off the intraday top as global sentiment in the region is risk-off.

Chinese markets underperform, especially the property sector, on the announcement of measures to ease speculation. EUR/USD dropped temporary to the 1.19 area on the outcome of the German election. For now, the loss of euro is modest (currently around 1.11930/35). The New-Zealand election brought also a diffuse outcome as the ruling National party didn’t get a majority. NZD/USD declined from the mid 0.73 area to the mid 0.72 area.

Today, the German IFO business Climate is expected virtually unchanged at the highest level ever. We don’t have strong evidence to take a different view from the consensus. There also plenty of ECB and Fed governors scheduled to speak, including ECB Constancio, Mersch, President Draghi and Coeuré. From the Fed side, NY Fed Dudley and Chicago Evans are the speakers on duty. Dudley’s speech probably won’t address monetary policy. Evans is a dove and was probably one of the governors who don’t see a rate hike anymore in 2017.

Last week, the dollar remained soft even as the Fed reiterated its intention to continue policy normalization. The euro profited slightly from strong PMI’s. Today, the focus might be on the consequences of the German election outcome. The IFO will have to bring a big surprise to have impact on euro trading. The German election outcome is less positive for the EU and intra-EMU cooperation. This might widen intra-EMU spreads and cause some euro softness. At the same time, the sources of uncertainty that weigh on the dollar have still not gone. We start the week with a slightly euro negative bias. However, it is far from sure that the outcome of the German election will start a real sustained euro down-leg. EUR/USD 1.1823 remains to first reference

From a technical point of view EUR/USD hovers in a consolidation pattern between 1.1823 and 1.2070. It was disappointing for EUR/USD bears that the recent correction didn’t reach the range bottom. More confirmation is needed that the bottoming out process in US yields and in the dollar might be the start of more sustained USD gains (against the euro). In case of a break, next support in EUR/USD comes in at 1.1774 and 1.1662

The day-to-day momentum in USD/JPY remains more constructive. However, this in the first place due to yen weakness. USD/JPY regained the 110.67/95 previous resistance, a short-term positive. Unless an unexpected risk-off event, the yen might remain in the defensive. The 114. 49 correction top is the next important reference.

EUR/USD: Will German election cause a euro negative repositioning?

EUR/GBP

No lasting sterling damage from Moody’s downgrade

On Friday, sterling was at the mercy of the broader swings in the euro and the dollar as markets awaited UK PM May’s Brexit speech in Florence. UK PM May brought some general considerations on the relationship between the EU and the UK, but stressed that the UK intends to maintain the best relations with the EU. The UK PM also advocated a transition period. Sterling initially declined, but soon regained most of the lost territory as the tone of the speech was reconciliatory. The reactions from Europe were mildly positive. Later in the session, the sterling faced another headwind as Moody’s cut the rating of the UK from Aa1 to Aa2. This downgrade hammered sterling. EUR/GBP closed the session at 0.8850. Cable finished the day at 1.3504

Today, the euro is slightly in the defensive after the German election result. EUR/GBP dropped again to 0.88 barrier. Sterling profits from both underlying euro and USD softness and this may still go somewhat further. The recent lows in EUR/GBP (0.8775 area) are within reach.

EUR/GBP made an impressive uptrend since April and set a MT top at 0.9307 late August. Recent UK price data amended the dynamics and the reversal of sterling was reinforced by hawkish BoE comments. Medium term, we maintain a EUR/GBP buy-on-dips approach as we expect the mix of relative euro strength and sterling softness to persist. However, the prospect of (limited) withdrawal of BOE stimulus put a solid floor for sterling ST term. We look how far the current correction has to go. EUR/GBP is nearing support at 0.8743 and 0.8652, which we consider difficult to break. We start looking to buy EUR/GBP on dips

EUR/GBP: near recent lows

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This non-exhaustive information is based on short-term forecasts for expected developments on the financial markets. KBC Bank cannot guarantee that these forecasts will materialize and cannot be held liable in any way for direct or consequential loss arising from any use of this document or its content. The document is not intended as personalized investment advice and does not constitute a recommendation to buy, sell or hold investments described herein. Although information has been obtained from and is based upon sources KBC believes to be reliable, KBC does not guarantee the accuracy of this information, which may be incomplete or condensed. All opinions and estimates constitute a KBC judgment as of the data of the report and are subject to change without notice.

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