EUR: Guided by the political themes - Rabobank

Jane Foley, Research Analyst at Rabobank, the better tone of the EUR earlier this week was linked with news that Fillon has won the first round of France’s Republican primary and as such it provides a sign that the market’s focus is being drawn back into European politics.

Key Quotes

“The latest round of pressure on the Italian bank is reportedly related to concerns about its ability to complete a EUR5 bln recapitalisation in an environment of renewed political tension.  A “no” vote in the December 4 Italian referendum on constitution reform has the capacity to trigger a collapse of the government and could potentially usher in a new phase of uncertainty over Italy’s very participation in EMU.  If PM Renzi were to resign on the back of a ‘no’ vote in the referendum, risk is that elections could ensue.  Italy has three opposition parties which favour exiting the EUR.  These are the Five Star Movement, Forza Italia and the separatist Lega Nord.  For investors in Italian banks the current set of risks may be complicated by the fears that a EUR denominated asset could be replaced by lira.  Over the weekend, Renzi employed celebrity power to encourage backing of his constitutional reform programme which would reduce the power of the Senate and take back powers from regional governments.  However, last week’s opinions polls suggest that he is facing an uphill battle.  Much of the electorate is reportedly viewing the referendum as an opportunity to protest against the government in general.” 

“It can be assumed that the EUR would benefit from a ‘yes’ vote in the December 4 referendum.  The EUR would also likely benefit if Fillon were to proceed through the next round of France’s Republican party’s primary to become its candidate for next year’s Presidential election.  To date opinion polls have been suggesting that the Republican Party’s candidate is likely to beat the far-right’s Le Pen in the second round of next year’s Presidential election. Clearly there has been a rise of distrust in opinion polls given their failure to predict the outcomes of the UK’s general election and Brexit votes in addition to the Trump’s presidential victory.  That said, anticipation that France will not be won by the nationalist stance of Le Pen should allow the EUR to retain its composure.  Fillon is an admirer of Thatcher and, with his promises of labour market reform, he is likely to win a vote of confidence from the market.”  

“Although the French Presidential election is very capable of injecting a significant degree of volatility into markets in the coming months, the result of the first Republican primary has brought a little welcome clarity into the outlook.  That said, the uncertainty connected with the Italian referendum is significant and should limit upside potential for the EUR in the near-term (no more opinion polls will be published ahead of the Dec 4 vote).” 

“For EUR/USD, activity in the last couple of weeks has been dominated by movements in the US yield curve.  Although there is limited US economic data scheduled for the week, the market will still focus on the comments of various Fed officials.  It is our view that the market may have priced in too much reflationary pressure into the US yield curve on the back of the Trump victory and that yields and the USD will correct lower medium-term. On a 3 mth view we expect EUR/USD to have rebounded towards 1.08 – assuming Renzi remain Italy’s PM.”