Euro-Dollar Rate Under Pressure as German Election Result Poses Fresh Uncertainty and US Tax Reform Talk Boosts USD

Germany's election outcome could mean Eurozone integration takes a back seat and leaves the EUR/USD rate at the mercy of central bankers and politics in Washington once again.

The Euro-to-Dollar exhcange rate is under pressure in early trading as markets digest the implications of a German election that saw electoral support migrate away from the traditional pillars of German politics and into the hands of smaller alternative parties who threaten a shakeup of the status quo in Berlin.

Sunday’s election ends the grand coalition between Merkel’s CDU and Martin Schultz’s CSU and marks the beginning of what could be weeks-long period of coalition building for Chancellor Angela Merkel. The most likely outcome is seen as a so-called Jamaica coalition involving the CDU, the Green Party and Die Link.

“With a poor result for the Grand Coalition parties (CDU and SPD), the SPD declared it will go into opposition, implying that forming a new government may be difficult and that it will be more restrained on the European agenda,” says Guy Stear, an economist with Societe Generale.

The Euro-to-Dollar pair opened some 50 points lower, at 1.1902, on Sunday night and was charting a return toward this level as of the opening bell in London Monday, following an overnight attempt at paring losses.

What Does It Mean For The Euro?

For the Euro, this could draw the curtain on any further Eurozone integration in the very short term as the Greens, which are the larger of the two prospective coalition partners, have opposed further Eurozone fiscal integration.

The result may come as a disappointment for some investors and traders because after the election of Emmanuel Macron in France, some had seen the German election as the last remaining hurdle to further integration among Eurozone member states. This could have seen the creation of a Eurozone finance minister, a Eurozone budget and led to more fiscal control being transferred toward the centre.

“A Jamaica coalition would likely make it more difficult to pursue further euro area reform. Making tough decisions with only a fragile 52.4% majority is hard,” says Tomasz Wieladek, an analyst at Barclays. “The AFD result could move some CSU politicians towards a more hawkish stance on fiscal risk sharing. The Greens and FDP also have opposing views on EU policy.”

France’s President Macron has been scheduled for some weeks now to deliver a speech on Tuesday setting out his vision for the future of the Eurozone, a speech which has been expected to yield promises of reform and further integration at the European level. Markets had been pricing an acceleration of Eurozone over the coming quarters, in part due to these anticipated measures.

“It’s now or never for a EUR/USD correction. The euro has done better than shifts in relative interest rates, short or long-term, nominal or real, can justify,” says Kit Juckes, a strategist at Societe Generale. “EUR/USD 1.17 is a natural chart target and may well be tested in the weeks ahead.”

Meanwhile analysts at UBS are unconcerned over the Euro's fall and flag that the Euro's overall decline has been fairly orderly.

"So is this just a minor bump in the EUR rally and an opportunity to buy? Data has been strong again last Friday and seems that recovery is gaining traction," says a note from UBS' spot desk released on Monday morning.

"From a technical point of view a strong support comes in around 1.1860/70 (trend channel going back to April) and the way it has been holding since the opening, I prefer to buy around 1.1900 today," adds the note.

US Tax Reform Could Mean Further Losses For Euro-to-Dollar

Beyond Germany, Monday and the ensuing week brings with it a range of central bank speeches, including the appearance of European Central Bank president Mario Draghi in Brussels at 15:00 Monday.

“President Draghi speaks in Brussels today at 15:00 CET, delivering the ECB’s perspective on monetary developments. We note that EUR/USD is very close to good support levels at 1.1860/1900 and failure of Draghi to give the EUR a boost today could leave it more vulnerable to US tax reform later in the week,” says Chris Turner, head of foreign exchange strategy at ING Group.

Expectations of ECB policy normalisation are underwriting the Euro at present, helping to offset some of the election pressure, although this could change later on Monday or around the middle of the week.

“It looks as the Trump Administration will this week try to re-launch its tax reform policy....We only mention this as an upside risk to the dollar this week, since so little is priced for Trump policy and the speculative market has sizable dollar short positions,” says Turner.

Markets had written off any prospect of tax reforms coming from Washington over the short term, given the Trump administration’s difficulty delivering on many of its other policy objectives. However, recent cross party cooperation on the debt ceiling and Hurricane Harvey relief, which saw President Trump stepping across the aisle to strike a deal directly with senior democrat politicians.

The prospect of further cross-party cooperation cannot be ignored and could mean traders are underestimating the administration’s ability to get tax reforms through both houses of government.