The Week Ahead: Elections have Consequences

Foreign Exchange: The Week Ahead
Elections have Consequences
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Market action last week was dominated by the escalation in tariffs between the US and China, but Europe has also had its share of market-moving events. 

Much of the headlines surrounding Europe speaks to the European Parliamentary elections on May 23-26 and understandably so.  From the UK’s point of view, these elections represent a proxy for voter sentiment on both the path of Brexit and support for each individual political party.  As such, the outcome should play a role in the future path for Brexit. 

From the EU’s point of view, this election carries significance as populist parties are projected to increase their combined representation.  It is important to note that this most likely just confirms the increased fragmentation in Europe.  Populist parties in the EU lack a common ideology and as such are unlikely to form a large enough coalition to materially influence policy.  Moreover, history shows that even outright populist governments do not automatically equal euro break-up risks, further reducing the election result’s impact on the euro. 

Instead, the bigger risk in Europe appears to be the Italian situation.  New forecasts out of the EU raise the possibility that Italy could, once again, face Excessive Deficit Proceedings when country specific recommendations are published after the EU elections.  However, the possibility for early Italian elections could nudge the EU away from direct confrontation. 

Ultimately, the issue isn’t how tolerant the EU is of Italy’s debt overshoot but rather Italy’s ability to service this debt.  Confrontational rhetoric between Italy and the EU feeds a negative loop where higher interest rates lead to less debt stabilization which leads to higher interest rates.  Certainly, this is a combination that is less than ideal and merits monitoring.

MAJOR CENTRAL BANK ACTIVITY THIS WEEK

5/20 Israel Expectations for rates to remain unchanged at 0.25%

KEY MARKET MOVING ECONOMIC RELEASES

United States and Canada

5/21 Existing Home Sales Expectations for a 2.7% MoM gain
5/23 US Manufacturing and Service PMI Expectations for a 52.7 and 53.5 print, respectively 
5/24 Durable Goods Expectations for a 2.0% decline

Europe/Eurozone 

5/23 EZ Manufacturing and Services PMI Expectations for a 48.1 and 53.0 print, respectively 
5/22 German Q1 GDP Expectations for 0.4% seasonally adjusted gain
5/23 German Manufacturing and Services PMI Expectations for a 44.8 and 55.4 print, respectively
5/22 U.K. CPI and PPI Expectations for a 0.7% and 0.3% MoM rise, respectively

Asia/Japan, and New Zealand 

5/19 Japanese Q1 GDP Expectations for a -0.1% decline
5/23 Japanese National CPI Expectations for a 0.9% rise

FORECASTS

EUR

The euro should remain pressured this week as the prospect of protracted trade disputes weighs on global trade, an area that the EU has high exposure to.  Additionally, rhetoric in Italy increases the probability of renewed tensions with the EU.  US auto tariffs have officially been delayed, but this represents a tactical extension given the focus on China and not a change in the ultimate likelihood they are realized.

GBP

The GBP has been the worst performing G10 currency over the past two weeks by a wide margin.  This price action represents the market’s reassessment of its assumption that a parliamentary majority will prevent a no-deal Brexit in light of PM May’s impending departure.  The upcoming EU parliamentary elections should serve as a proxy for public sentiment.  Expect the GBP to remain under pressure.  

JPY

Risk-off flows into the safe haven yen have made the JPY the G10’s top performing currency since the beginning of the month.  With both the U.S. and China increasingly entrenched in their respective positions, expect resilient safe haven demand.

CAD

An agreement between the US and Canada on steel and aluminum tariffs provided the CAD with a boost.  However, the main issues for Democrats (enforcement and environment) remain unresolved, warranting caution on extrapolating USMCA ratification.   Bias is for further CAD weakness as commodity currencies get hit by global growth concerns. 

CNY

Market indications are increasingly pointing to an extended period of trade tensions between the US and China.  As such, the CNY has been one of Asia’s worst performing currencies on the view that China will be hurt more than the US during a trade war.  Dollar strength and further easing from China should further weaken the currency.  Reports have circulated that China isn’t keen to see USDCNY weaken beyond 7.  It remains to be seen how strong this defense will be if Chinese market measures remain stable. 

AUD

Trade tensions and monetary policy concerns have pushed the AUD lower.  The RBA has indicated that the labor market would be a key factor in its future rate path.  To this end, the most recent employment report showed an increase in the unemployment rate which has fueled speculation that rate cuts could be move up.  Continued downward pressure is expected.
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