EURCHF pressing higher suggests that the German election result has not undermined pro-EUR sentiment, with the initially lower EURUSD entirely due to USD strength. The Social Democrats (20.4%, -5.3%) showing their worst election result since WWII and the CDU/CSU (32.8%, -8.7%) falling back to its second weakest historic result suggest that the episode of strong centralist ‘people parties’ has come to an end in Germany too.
With the SPD ruling out re-entering a coalition under the lead of Chancellor Merkel makes a CDU/FDP/Greens coalition the only option leaving a minority government aside. With the FDP (10.7%, +5.9%) and the Greens (9%, +0.6%) two progressive parties are set to enter the government provided that coalition talks come to conclusive results.
EUR: Interpreting the German election. The FDP has a reputation for market liberalism, but being cautious on euro-reform. In this respect it was interesting to see its leader Lindner using more constructive language in post-election Sunday evening debates calling the FDP pro-European and open to EU reforms. The Green party program has called for the introduction of Euro-bonds,a position which had been opposed by the previous CDU/SPD government. The AfD (13%, +8.3%)has benefited from its anti-immigration agenda and implicit anti Merkel sentiment witnessed mainly in the east. Our economists have taken a critical view in respect of this new political constellation in Germany. EUR:From theFrench side. The French President Macron will set out his vision concerning necessary EU reforms tomorrow.
Most of his proposals have been adapted from his predecessor Hollande, but the April/May French election campaign with its strong populist showings suggests that this current French government must be a success to avoid the risk of the next French President running on a populist anti-EU agenda. This weekend’s Senate election in France showed Macron’s party only taking less than 8% of the seats and its popularity ratinghas fallen at a faster pace than the popularity of Hollande at this stage of the Parliamentary cycle. Germany showing its securities statistics running excessive peripheral investments may have to opt for a policy of faster EU political integration to keep its investments safe. Even the head of the German employers association (BDI) Dieter Kempf suggested that Germany may have to change its surplus-generating economic model and investment more domestically.
A political EUR. The SPD opting for opposition has reduced Chancellor Merkel’s negotiating options down to one remaining coalition option (CDU,FDP, Greens). Normally, this should increase the pace of negotiations, but ahead of the local election in Lower Saxony on 15 October little will happen. Thereafter we will see if Germany allows the EMU reform agenda to accelerate or not. If not, EMU economic divergence and institutional insufficiencies will persist, leaving the ECB as the only institution trying to keep the EUR together. In this case, EMU spreads would widen, the EUR would decline and German investors would lose out. The alternative suggests not only the opposite; it would also contain the better answer to Brexit, Donald Trump and the risk of populism taking the European project apart.
The USDJPY and USDCHF bull: This EMU view has implications going beyond EUR denominated capital markets. The glut of European savings has been pushing bond yields globally lower. Now this glut of savings may abate with inner EMU investment increasing at a faster pace than the generation of domestic EU savings. We look back to autumn 2005 when, in the aftermath of China’s USD de-peg, Asian savings grew at a slower pace. Back then, global bond yields went higher making the JPY and the CHF good funding currencies. Now it may be the glut of European savings due for a decline which should have similar consequences to what was observed in autumn 2005. The lower savings meets a market where hedge funds have turned negative on the USD while the Fed sounds increasing hawkish. We think this has created an ideal environment for USDCHF and USDJPY to rally . The head of the San Francisco Fed has shrugged off concerns over the recent persistent inflation under-shooting, arguing that the “strong” economy mean the felt confident that prices would rise and justify higher interest rates. Partial USD strength. Finally, New Zealand’s election results were inconclusive with the National Party (58 seats) failing to win an absolute majority (60 Seats), likely to enter a coalition with the anti-immigrant ‘New Zealand First’ (9 seats). There is a chance that NZD rallies when a coalition is ultimately formed but we think it would be a rally to sell into. NZDUSD is one of our preferred pairs to trade the USD higher from ‘oversold’ levels bearing in mind that the highly leveraged NZ economy has developed signs of weakness. We are still long EURNZD. Japan’s PMI rising towards a 4 month high of 52.6 (52.2in August), plus strongly rebounding risk appetite, should leave the JPY offered. USDJPY is set to break higher. Superb liquidity conditions should keep EM supported.