EUR: Driven by politics – BBH

In view of analysts at BBH, the consensus narrative under-appreciates the importance of politics in driving the euro higher this year.  

Key Quotes

“Consider that through Q1, the dollar was consolidating its Q4 16 gains.  It then became clear in Q2 that the populist-nationalist moment that supposedly connected Brexit with Trump was not in fact coming home to roost in Europe.  The euro gapped higher on April 24; jumping above $1.08 not seeing it again.”  

“If Macron's election marks the euro's bottom, Merkel's re-election helps mark the top.  The implications of the changed coalition, a new cabinet, including a new finance minister, are far from clear.  The formal negotiations for the new government are just beginning, and it will likely take most of the rest of the year, if not longer, to reach an agreement.”  

“Merkel will also have to close ranks with the Bavaria-based CSU, which had considered running a candidate against her.  The CSU and Merkel's right-flank have been critical of her immigration policy as leaving them vulnerable to the AfD.  The AfD drew their support heavily from the former eastern states that had less exposure to immigrants.”  

“At the same time, Spanish and UK politics are also impacting investors.  The underperformance of Spanish assets is clearly tied to the anxiety over Catalonia's push for independence and Madrid's response.  The meeting of Catalonia's regional government was supported to take place on October 9, but the meeting was suspended by the Spain's Constitutional Court.  The effect of the suspension is not clear.   Presently, it almost feels like both Catalonia and Madrid are taking a collective deep breath and reconsidering the options.”  

“The Catalonia leaders may have bitten off more than they can chew.  A declaration of independence, which they have given their followers reason to expect, can be seen as a declaration of war.  Madrid would have little choice to resist, which could take different forms, including the suspension of the local government.  It could include occupying Catalonia and arresting the leaders as traitors.”  

“An independent Catalonia would be an economic challenge.  Yes, it is true that Catalonia accounts for about a fifth of Spain's economy.  But severed from Spain, it would likely shrink.  Press reports indicate that several companies, including banks, are or considering registering outside of Catalonia.  As Montreal can tell Catalonia, even if secession does not take place, the mere threat can have far-reaching effects.”    

“There are many issues that may not have been thought out.  Catalonia's leaders have threatened to declare independence.  What currency would they use?  How would they service their debt?  What is their responsibility for the federal debt?  There are countless moving pieces, and they require time and institutional capacity.  It is not the same as running a region.  Catalonian officials have ultimately fanned unrealistic expectations, and there will be an economic and political price to pay.”