Barclays says Political Risks Creep Back Into The EUR

  • If confirmed, the surprising gains by alternative parties and poor performance of the centre establishment parties in Germany's election subtly reinserts politics into the debate over the EUR's value. Most of the EUR's gains have come since the French election, with many pointing to the reduction in perceived political risks to the EU and EMU as important contributors to the common currency's ascent. Yet, as we noted following the French election has gained steadily in all of this year's elections, despite the French two-stage electoral system keeping Front National out of government. Indeed, elections in Europe are going much as we predicted at the start of the year.
  • However, in our view, most of the EUR's gains are due to the sharp improvement in the euro area economy in the last 18 months and the German election will do little to endanger that. Hence, we do not expect significant EUR downside to result from the election. But, it likely will sap further EUR momentum that has stalled in the last two months. Longer-term asset allocators and reserve managers may pause in thinking that long-term political risks have disappeared from the euro area, while short-term and leveraged investors may take a more cautious approach in a currency with substantial negative carry if expectations for near term appreciation fade.

Looking ahead

  • results of the German election may cause more FX market focus on and angst over the Italian election in early 2018
  • Unlike the Dutch, French and German elections where alternative parties were never in realistic contention to form a government, an alternative, anti-euro party, the Five Star Movement (M5S), is at rough parity in the polls with both the centre-left and the centre-right blocks.
  • While its path to government still is less likely, it is not statistically remote as has been the case in other European elections. Depending on whether or not the Italian electoral law is amended to lessen M5S's chances of victory and the evolution of polls, this may add a negative tone to the EUR in Q118
  • ... nervousness ahead of the upcoming Catalonia referendum on 1 October

(bolding mine)