German Elections Preview: What to expect of EUR/USD?

It’s the decision time again in Europe. Germans shall head to the voting polls on September 24 to choose the makeup of their main legislative body, the Bundestag, which will in turn choose the next chancellor.

As of now, the largest parties in the Bundestag are CDU/CSU [consider them as one party] and the centre-left SPD. CDU is Angela Merkel’s party, currently in governing coalition with the SPD.

Before discussing the stance of the political parties and the various election scenarios, it is worth noting that the EUR-

• Would respond positively to an outcome that boosts the Eurozone-US growth/inflation differential
• Is positive for the Euro project

Political parties in the race

What polls say?

It is being reported that Angela Merkel squashed her opponent, SPD’s Schulz in TV debate yesterday.  Polls following the 90-minute showdown gave Merkel, leader of the Christian Democratic Party (CDU) since 2000, a clear edge over Schulz, a former European Parliament chief and leader of the Social Democratic Union Party of Germany (SDP).

Munich’s Merkur daily noted that “in an increasingly uncertain world which is led by the testosterone-filled leaders, people don’t know what Schulz wants. But they know what Merkel can do.” There is widespread feeling that Schulz is coming-off as just another election candidate, while Merkel maintains her charm as ‘stateswoman’.

Polls certainly suggest Angela Merkel will win a stunning fourth term as Europe’s most powerful leader. Still, it isn’t a done deal. Following scenarios should be taken into consideration before trading the Euro.

Scenarios

Clear victory by Merkel: This is more of a same kind of situation in Germany and Eurozone. Approving bailout packages will be easy; there will be more room for Eurozone financial integration. The idea of the European monetary fund will gather traction. Finance Minister Wolfgang Schaeuble wants to run fiscal surpluses every year until 2020 and has only vaguely hinted at tax cuts. So there is little scope for fiscal reflation… Impact on EUR/USD: mildly positive, Focus would shift to the ECB.  EUR/USD could rally sharply if Merkel changes her stance following a clear vitory and talks about reflating the economy.

Tight victory by Merkel: Polls suggest Merkel will be short of a parliamentary majority in the Bundestag and will need weeks, if not months, to form a new coalition government. A small majority for Merkel would make her vulnerable during if there’s a new crisis in the Eurozone.

Merkel forms a coalition with FDP: This is the most likely scenario. Approving bailout packages for Greece or other crisis-hit countries would be difficult, Merkel’s domestic wiggle room for a Franco-German deal on integrating the euro zone’s finances more closely would be narrow. As the Reuters report says, “Forces that threatened the euro’s long term future lost out in elections in France and the Netherlands. In Germany, they may come from within.”However, all is not lost. FDP is pro-business and wants to cut income tax by at least 30 million Euros. This is somewhat reflationary scenario. Furthermore, German criticism of the ultra-lose euro zone monetary policy would intensify. Impact on EUR: A minor initial sell-off likely. Next move depends on the sound bites - if in support of reflationary policies, EUR would rally.

Schulz win: Schulz has promised to cut taxes for anyone earning less than 60,000 euros - a measure that would benefit nine out of 10 German workers - and to reduce social security contributions for those earning up to 15,000 euros a year. Schulz also wants to spend 30 billion euros more on public investment by 2021. He wants to raise taxes for top earners. German bond yields are below zero for maturities out to seven years and the RWI think tank forecasts a 2018 budget surplus of 28 billion euros, or 0.8% of GDP. So Schulz has enough room to reflate the economy or run down fiscal surplus. This is positive for the Eurozone as a whole as increase in German domestic demand could help crisis-stricken countries rebalance their economy. Thus, a strong majority for Schulz is EUR positive. An initial sell-off would be quickly undone. Also note that, Schulz’s policies can easily be adopted by Merkel following a victory in the elections. Any outcome that boosts the odds of the reflationary fiscal policies is EUR positive… not only will it strengthen Eurozone growth story, but would also create room for the ECB to taper its QE program. Impact on EUR: An Intraday sell-off could be followed by a sharp rebound and rally to 1.24 handle in the subsequent days, especially if the new Chancellor talks about delivering tax cuts and public spending. 

EUR bearish scenario: A surprise victory for anti-EU populist parties or Merkel coalition with populist parties or Schulz coalition with populist parties could push EUR/USD below the 10-month MA level of 1.14.

Technicals - Monthly chart

• A bullish RSI followed by an upside break of the falling channel suggests the bulls are in control and doors are open for a rally to the falling trend line resistance seen around 1.24 handle.
• The RSI is sitting around 60.00 levels, sloping upwards, thus suggesting plenty scope for a rally to 1.24 handle.
• On the downside, only a drop below the 10-month MA would signal bullish invalidation.
• On a larger scheme of things, trend reversal is seen only if the spot suffers multiple weekly close below 1.14.