Is it me, or is the euro having trouble sustaining bullish momentum these days?
So, why is the euro having trouble gaining ground against its major counterparts? More importantly, why aren’t traders talking about any potential recovery for the common currency despite its oversold status?
Let’s explore four factors that could negatively affect the euro in the next couple of months:
Full steam ahead for the ECB
Earlier this year, the European Central Bank (ECB) surprised markets by keeping calm and carrying on with its already stretched stimulus programs despite the significantly improved inflation prospects.
It’s not because Draghi and his team are into alternative facts, though. Instead, the ECB simply attributed the faster inflation to volatile increases in energy prices and said that “there are no convincing signs yet of an upward trend in underlying inflation.”
In its January policy statement, the central bank even outlined the four conditions that would tell them if the rise in inflation is “sustainable.” Draghi pushed the knife a little deeper a few days later when he emphasized that economic conditions in the euro zone “have improved, but all this doesn’t mean that we can relax.”
Despite that, some analysts say that he and his team are only waiting until the end of summer (read: after the Dutch and French elections) to start tapering its stimulus. Do you agree?
Grexit: Season III, Episode MDCCXLIX
On this month’s episode, Greece’s main creditors – European lenders and the IMF – are having trouble closing the second review of Greece’s third bailout signed last August 2015. An approval would pave the way for Greece to get another loan, this time to pay around €7.5B worth of debts due in July.
Unfortunately for Greece, the IMF is saying “pass” even as it encourages European governments to loosen their purse strings and ease their targets. It warned that “Greece cannot be expected to grow out of its debt problem, even with full implementation of reforms.”
The problem is that European creditors believe otherwise. What’s more, key creditors such as the Germans and the Dutch also won’t give their thumbs up without the IMF.
And if those aren’t bad enough, Greece also doesn’t plan on bringing anything new to the bargaining table either. Earlier this week, Greek government spokesman Dimitris Tzanakopoulos said that “Our aim continues to be an agreement with not even a euro more of additional measures.” Yikes!
“Super Election Year” could mean existential crisis for the euro
I mean, who isn’t having one these days? But in the euro zone’s case, a series of events could literally spell the end of the EU’s common currency project. Duhn duhn duhn.
The issue on the table is the possibility of populist, Eurosceptic politicians – those who have hinted or actively stated that they want to follow Britain’s footsteps and exit the EU – could very well win their respective elections this year:
Netherlands: Freedom Party vs. People’s Party for Freedom
On March 15, 31 parties will compete to get seats in the Netherlands’ 150-member parliament. Top contenders include Geert Wilders and his Freedom Party and Prime Minister Mark Rutte and his People’s Party for Freedom.
Wilders’ Trump-like, anti-establishment and anti-immigration sentiments are expected to win his party 27 seats, while Rutte, who is banking on a strengthening economy, is expected to snag 23 – 24 seats.
A Freedom Party domination won’t necessarily translate to a “Nexit,” though. See, it requires 76 seats to form a government, which makes a coalition of 4-5 parties all but inevitable. Unfortunately for Wilders, all but one party have ruled out sharing power with his party, whose promised policies are bordering on offensive and unconstitutional.
France: Le Pen vs. Macron vs. Fillon
Latest opinion polls in France show right wing leader of National Front Marine Le Pen breezing through the first round of voting in April 23. She’s expected to get 26 points, a full five points ahead of pro-EU, former economy minister Emmanuel Macron’s 21 points. François Fillon, a centre-right candidate, is trailing with 20 points.
The second round on May 7 is bound to be more interesting, with polls widely favoring Macron (62) against Le Pen (38) should he win in April. Second-round odds aren’t looking too shabby for Fillon either, as he got 57 against Le Pen’s 43.
Germany: Angela Merkel’s CDU vs. everyone else
After electing former foreign minister Frank Walter Steinmeier as President on Sunday, Germany’s voters will now focus on the federal elections on September 24.
Market players have their eyes on right-wing Alternative for Germany (AfD), which is headed by Frauke Petry and is expected to get enough votes to finally win seats in the Bundestag after failing to meet the 5% threshold in 2013.
Attention is also on the Social Democratic Party (SPD) under Martin Schulz, a former head of the European Parliament and is a strong contender against Merkel and her Christian Democratic Union (CDU). The SPD is already under Merkel’s “grand coalition,” but Schulz has positioned himself as a straight-talking, anti-elite “outsider” who favors the common man.
Latest polls by Forsa put CDU with 34% of the votes, closely followed by the SPD (31%) and then the AfD (9%).
Italy: Early elections in the works?
A ruling by Italy’s constitutional court last week paved the way for pushing elections as early as this year. Its decision is based on proportional representation in the lower house Chamber of Deputies and hands parliamentary majority to any party winning 40% of the winning vote. However, the court also scrapped the “run-off” second round between the two largest parties and said that voting will only be held in one round.
The new rules all but assure a coalition government, and gives advantages to traditional parties such as Matteo Renzi’s Democratic Party while challenging parties like Beppe Grillo’s Five Star Movement, which has refused to form alliances.
But only President Sergio Mattarella can dissolve the parliament and he’s not too excited about it. For one thing, calling for early elections would expose Italy to unnecessary uncertainty ahead of the G7 meeting in Sicily in May.
Remember that Eurosceptics don’t have to win a referendum to cause trouble for the euro. At this point, even the act of scheduling a vote could inspire enough uncertainty to send financial markets into its global crisis levels.
The “Doom Loop”
Government bonds from the euro region are particularly vulnerable to investor confidence changes. After all, uncertainty over an economy discourages investors from buying bonds, which results in lower prices. The problem is that a lot of European banks tend to hold their respective government’s bonds.
The “doom loop” is triggered when a loss of confidence causes a selloff in bonds. Profits of banks that hold said bonds would take serious hits and make banks more likely to ask for bailout money. The government, already burdened with higher debt (from higher bond yields), would have little choice but to bail them out or risk further erosion of investor confidence.
France’s government bonds are already on the move thanks to the increasing possibility of a Le Pen win. An average of €16B was traded each day in February, double the €8B average recorded last year and marks the largest volume recorded since the 2010 – 2012 financial crisis.
Meanwhile, other analysts are worrying about Italy, the region’s third largest economy. Italy’s banks are the biggest holders of their sovereign debt, which makes them most vulnerable to a “doom loop.”
If opinion polls in the next couple of weeks favor Eurosceptic politicians, then uncertainty will remain the name of the game for the euro zone. This could not only lead to downtrends for the euro, but also real threats to the region’s banking system.
But if the safer and (currently) more likely scenarios play out and the major event risks are averted, then we’ll likely see relief rallies for the common currency.
There you have it, folks! I hope this list helps you make decisions regarding your euro positions. How about you? Do you have any concerns on the euro that aren’t on this list? Why do you think it merits as a medium-term concern? Let us know!