Article / 20 November 2017 at 8:25 GMT

FX Update: Euro rally stumbles as German coalition talks collapse

Head of FX Strategy / Saxo Bank
Denmark
  • German 'Jamaica coalition' falls apart as FDP exits talks
  • EURGBP gaps lower on questions over Brexit negotiations
  • JPY stronger as long bond yields slide lower

Angela Merkel
Time for another vote? Photo: 360b / Shutterstock.com

By John J Hardy

The route to a majority German government via a so-called "Jamaica coalition" (named for the party colours aligning with those of the Jamaican flag) of the liberal-leaning FDP, the right-centrist CDU/CSU, and the environmental Green party was always going to be an awkward proposition, but now it appears that it won’t be a proposition at all as the FDP walked out of coalition talks over the weekend.

The FDP couldn’t be moved on key issues that were likely a significant contributor to their strong electoral result of nearly 11% (after falling under the 5% threshold of representation in 2014). Chancellor Merkel will now face the difficult task of whether it will attempt to form the first minority government in postwar history or to call new elections, something that has likewise never happened since 1945. 

The euro gapped lower to start this week’s action to absorb the news with a push lower in EURGBP especially interesting as one wonders how united a front the European Union negotiators can bring to the table in Brexit talks. 

Shortly put, the political situation in Germany is unprecedented and this will weaken Merkel’s ability to govern. 

Elsewhere, the yen continues to push stronger as long bond yields have continue to slide and risk appetite has suffered a few wobbles. Many are noting the very large JPY short positioning in the latest US weekly CFTC positioning update, which is reaching its most extended level since a brief time back in late 2013 (when the Bank of Japan’s radical policymaking was having its most dramatic impact on the yen). 

USDJPY has settled into a pivotal area near 112.00 that is critical for the outlook from here with further moves in risk appetite and especially bond yields as the key drivers.

Looking forward to the rest of the week, it is rather light on important economic data and rather heavy on central bank minutes, with the Reserve Bank of Australia minutes up tonight, Federal Open Market Committee minutes on Wednesday and European Central Bank minutes on Thursday. 

With little at stake in the immediate forward expectations from any of these central banks, we’re not looking for these to serve as notable triggers. For the FOMC, the rate hike for December is virtually 100% priced-in and the market has even moved a bit beyond 50/50 for a move in March and continues to add a few basis points here and there for forward expectations. 

One thing worth noting here is that the 2-year US benchmark has advanced in a nearly straight line from around 1.3% to 1.7% since early September.

Chart: EURUSD

The EURUSD rally remains theoretically intact as long as we remain above the 1.1675-1.1700 pivot zone that was important on the way back up recently. It’s difficult to read how the market should treat the German political situation as it doesn’t necessarily feed into any policy considerations in the near term or the ongoing strong EU economic backdrop.

eurusd

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Source: Saxo Bank 

The G-10 rundown

USD – the greenback is not cutting much of a profile recently; it is in fact rather neutral to the other currencies that are providing most of the impetus, from last week’s very strong euro to the attempted JPY recovery into today and the sharply weaker G10 small currencies of late. We need meat on the bone on tax reform (very unpopular according to polls and the Senate votes not there using the current formulation) or a more notable rise in Fed expectations to drive a stronger USD.

EUR – the single currency stumbling to start the week on the German political news, but tough to see how this feeds into a dramatic reassessment here and now. Let’s use EURUSD as the key proxy for EUR strength or not, with 1.1675-1.1700 the pivotal area to the downside as we note above, and a close back above 1.1800 a sign that the market is willing to look past the issue for now.

JPY – the JPY making a comeback on the strength of global long bonds, and perhaps even on the strength of the Japanese economy. USDJPY has settled into a pivotal area near 112.00, with a salient support just below in the form of the 200-day moving average and a prior range low, as well as the Ichimoku daily cloud lurking a bit lower still.

GBP – sterling putting up a fight on the German political news as a weakened mandate for the leadership of the EU’s largest economy seen as beneficial to the UK’s negotiating position on the margin. The Brexit news should pick up by later in the week as we await the UK’s response to the EU side’s request to hear what the UK is willing to pay for the Brexit divorce before talks can transition to trade.

CHF – EURCHF knee-jerking lower on the German political news, but let’s have a look at weekly sight deposits after the week before last week saw the largest drop for the cycle and we have briefly pushed to new highs in EURCHF last week. It would be a boost for the EURCHF rally for long yields to halt their slide.

AUD – RBA minutes up tonight... the RBA policy anticipation for next year has been slip-sliding away as low inflation and wage growth has dogged the Aussie, now joined with more pronounced weakness in mining-related assets and key commodity prices. We continue to look lower for the AUD nearly across the board.

CAD – CAD hardly noticing the snap-back rally in crude oil on Friday, as indifferent CPI data worked against the loonie’s favour and Canadian rates have failed to rise as quickly as US rates over the last two weeks as the market realises the Bank of Canada is in no hurry to tack on further rate increases after bumping the rate to 1.00%

NZD – the kiwi trying to hang in there after Friday’s break of the key 0.6818 level in NZDUSD – the action early this week to determine the quality of that break, but we’re negative on the currency – more on a capital account angle on the ban on foreigners purchasing NZ real estate and the risks from future policy making, even if the actual NZ rate spreads haven’t worked dramatically against the kiwi’s favour.

SEK - an interesting week for the krona after last week’s traumatic fall. Not sure what holds the rally back if the euro remains firm despite the German political developments.

NOK – as Norway’s government pension fund pulls the plug on its oil investments, is the market considering where NOK should be valued in a post-oil export world as well? Let’s see if EURNOK can get comfortable up here... if so, the risk of a continued slide in the NOK’s fortunes remains on the technical strength of the move. A reversal below 9.60-55 needed to indicate that the NOK is ready to put up a fight.

Upcoming Economic Calendar Highlights (all times GMT)

  • 0900 – Switzerland SNB Weekly Sight Deposits 
  • 1145 – ECB’s Nowotny to Speak 
  • 1215 – ECB’s Lautenschlaeger to Speak 
  • 1400 – ECB’s Draghi to Speak 
  • 1415 – ECB’s Constancio to Speak 
  • 1600 – ECB’s Draghi to Speak 
  • 1830 – UK BoE’s Ramsden to Speak 

— Edited by Michael McKenna

John J Hardy is head of FX strategy at Saxo Bank

21 November
pslaw pslaw
Hi John, is weaker German leadership in EU giving more advantages to UK on negotiation table? How about France has more says now? Macron has big plan for integrated EU and Paris currently benefits from brexit uncertainty ( gaining clients from London ).
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