Eurozone Economy, Politics, Policy Rate & Euro

Forecast “The Eurozone’s economic fundamentals are encouraging but the formation of a German government is probably a necessary if not sufficient condition for the Euro to enjoy a second (modest) wind following its 6% appreciation between end-2016 and end-July”. [Bond market bang, major currency whimper, 21 December 2017]

Outcome The Euro NEER remained within a 1.9% range over the following two months (with the formation of a German government still pending).

Forecast “The Euro is trading near the top of a narrow range. However, messy Eurozone politics characterised by nationalist currents are taking the shine off the region’s economic faster recovery and could ultimately act as a headwind to growth and Euro appreciation.” [Euro impervious to Eurozone’s political pantomime, 24 November 2017].

Outcome Euro NEER peaked on 24 November and then remained in narrow 1.1% range for the following 6 weeks.

Forecast “Option (2) [another grand coalition between the CDU-CSU and the SPD] may thus be the least unappealing for the normally pragmatic Chancellor, while the SPD and Schulz may have more to lose from new elections than the FDP and Greens.” [Euro impervious to eurozone’s political pantomime, 24 November 2017]

Outcome SPD members on 4 March 2018 voted 2 to 1 in favour of the SPD and CDU-CSU forming a grand coalition, paving the way for Chancellor Merkel to form a government almost six months after federal elections were held.

Forecast “Assuming, as I do, that clarity is provided to the above issues in coming weeks, this leaves the Euro in a good position to resume an admittedly slow upward trend. I expect the ECB to announce at its 26th October policy meeting an extension of its asset purchasing program into 2018 albeit with lower monthly purchases (from €60bn currently). Lower sovereign and corporate yields for longer would continue to drive economic activity and cap the risk of systemic defaults. This would be positive, not negative, for the Euro in my view based on the recent relationship between the EUR/USD cross and government bond yield spreads”. [My top currency charts, 13 October 2017]

Outcome The ECB announced a tapered but extended QE program on 26 October. This contributed to a further widening of the US Treasury-German Bund yield spread, which along with the ongoing recovery in Eurozone economic activity and business confidence, led to a further modest appreciation in the EUR-USD cross and 1.1% appreciation in the Euro NEER between 26 October and end-November 2017.

Forecast “I see little scope for rapid and/or sustained appreciation until the ECB announces the modalities of an extended QE program and a new German government is in place, with the risk biased towards bouts of Euro weakness”. [Uncertainty threatens euro’s safe-haven status, for now, 29 September 2017]

Outcome Euro was broadly stable between end-September and the ECB policy meeting on 26 October at which it announced a tapering of its bond buying program and remained stable in the week following the ECB meeting.

Forecast “The ECB is ultimately in a pretty comfortable position, in my view, and can probably afford to do and say little next week.” [We know what you did last summer, 1 September 2017]

Outcome ECB kept is policy rates and the modalities of its QE program unchanged at its 7 Sept 2017 meeting and did not specify at which meeting it would announce a likely tapering of its QE program.

Forecast While the ECB may be incentivised to slow the current rapid pace of Euro appreciation, at this stage I do not expect the ECB to try and to stop, let alone reverse, the Euro’s upward path.” [No UK rate hikes this year and room for further Euro upside, 28 July 2017]

Outcome Euro Nominal Effective Exchange Rate appreciated a further 1% in August 2017

Forecast “Capital inflows into the eurozone allied to a 2% of GDP current account surplus, a pick-up in economic activity and receding political risks following the French presidential elections are likely to extend the euro’s current rally near-term […]. After all Euro NEER is only 1.3% stronger than the average level recorded since early 2016. ECB appears comfortable with the common currency’s modest appreciation, perhaps unsurprising given that hawkish ECB Council members – led by Bundesbank – would like to see a tightening, even if modest, of eurozone monetary policy. With French elections out of the way, ECB may well subtly change its forward guidance at its 8 June policy meeting and announce its tapering intentions after the German elections in September.” [Politics suspected of interfering with economics and markets, 19 May 2017]

Outcome President Macron’s La Republique en Marche party in alliance with MoDem won 350 seats in the 577-seat National Assembly in the 18 June election, further dispelling the risk of nationalist parties dictating the political narrative. ECB tweaked its language on forward guidance at 8 June policy meeting and announced a reduction in its monthly asset purchases (as of 2018) at its 26 October policy meeting. EUR/USD and EUR/GBP appreciated 5.7% and 4.2%, respectively, between 19 May and late-July.

Forecast “I am also sticking to my forecast that Macron, who is leading Le Pen by 22 percentage points in the polls, will win the 7th May run-off to become President. […]. French opinion polls, historically accurate in “predicting” the outcome of the first and second round of presidential elections, have Macron comfortably winning the second round.” [7 reasons why Macron will become President and market implications, 25 April 2017]

Outcome Macron won the second round with 66% of the popular vote, broadly in line with opinion polls which had Macron winning about 62%.

Forecast “I am sticking to my core scenario that […] Emmanuel Macron will fill one of the top two spots to make it to the 7th May run-off, which in my view would be welcomed by French financial markets and the euro even if markets remain jittery over the next fortnight. At the same time, the ever-changing political scene in the UK can do little near-term to avert the headwinds to GDP growth stemming from falling real wages and retail sales. With this in mind, I see the risk to GBP/EUR biased to the downside in coming weeks.” [French politics, UK macro data and possible GBP/EUR downside, 21 April 2017]

Outcome Macron won the first round of the French presidential elections (24% of the vote) and GBP/EUR weakened 1.9% in the following three trading sessions. Following the UK general election on 8 June which saw the ruling Conservatives lose their parliamentary majority, GBP/EUR weakened a further 1%. GBP/EUR fell 4.3% between 21 April and mid-June from 1.19 to 1.1385.

Forecast “Nevertheless, I am sticking to my core scenario that Macron will make it to the second round which he would win regardless of whom he faces given his strong cross-party political support and reasonably high popularity amongst voters […]. More recent surveys point to voter turnout of about 80% – which would be broadly in line with the average of the past nine presidential elections. Precedent would suggest that no candidate will materially benefit.” [The Ultimate Guide to the 2017 French Elections – Part IV, 13 April 2017]

Outcome Macron won the first round of the French presidential elections with 24% of the vote. An average voter turnout of 78% seemingly conveyed little or no advantage to any of the candidates with the outcome of the first round bang in line with opinion polls. Politicians across the political spectrum rallied behind Macron who comfortably won second round.

Forecast “Opinion polls accurately predicted the outcome of the 2012 and 2007 presidential elections and the eventual winner of the 2002 election […]. Le Pen and Macron still look on track to fill the top two spots in my view” [The Ultimate Guide to the 2017 French Elections – Part III, 5 April 2017]

Outcome Macron and Le Pen came first and second in first round with respectively 24% and 21% of popular vote, with Fillon and Mélenchon third and fourth respectively on 20% and 19%. Opinion polls very accurately predicted candidates’ ranking and share of national vote.

Forecast “Q4: The relationship between the number of sponsors and first round results is tenuous but suggests that Le Pen will fail to win the presidency. Q5: The large number of candidates points to the winner and runner-up of the first round winning only just over half of the votes, broadly in line with recent opinion polls. Q6: Precedent suggests that a small margin of victory in first round makes second round outcome harder to predict. This year’s election could prove a break with the past. Q7: Who came third or fourth in first round has on a few occasions mattered but assuming that Fillon comes third and left-wing candidates fourth and fifth, polls point to a convincing Macron win versus le Pen in second round.” [The Ultimate Guide to the 2017 French Elections – Part II, 29 March 2017]

Outcome There were 11 candidates in first round and Le Pen was sponsored by only 627 elected officials. First round was very tight – top 4 candidates each won 19% or more of the popular vote, with Le Pen second (only 21.3%), Fillon third (20%) and far-left candidate Mélenchon fourth (19.6%). Top two candidates won 45%. However, in the second round Le Pen won only 33.1% – well below the 44% historical average for the runner-up in a French presidential election.

Forecast “German general elections scheduled for September may well lead to a more divided parliament, making it harder to form a majority coalition government. But it is difficult at this stage to see who will realistically challenge Chancellor Merkel who is striving for a fourth consecutive election victory.” [Paradox of acute uncertainty and strong consensus views, 3 January 2017]

Outcome The CDU/CSU again won the largest number of votes and seats in the 24th September election and Merkel will for the fourth time lead a ruling coalition. However, the CDU/CSU is 109 seats short of a parliamentary majority, in part due to an unprecedented six parties winning seats in the Bundestag. The CDU/CSU will either have to re-form an alliance with the SPD or align itself with the Greens and FDP in the first ever 3-way government.

Forecast “If, as I expect, the eurozone economy starts to benefits from the euro’s depreciation and US yields stabilise or fall, this yield spread may no longer be sufficient to push the EUR/USD cross lower […]. Finally, the risk of European nationalist parties acceding to the highest echelons of power has been over-stated, in my view […]. It may be premature to go long EUR/USD but this may well be the trade to consider, particularly in the run-up to the French presidential elections in April-May 2017.” [Hawkish pendulum may have swung too far, 21 December 2016]

Outcome EUR/USD slowly pushed from a multi-year low of sub-1.04 on 21 December 2016 to 1.08 in mid-March 2017 (contrary to widespread market expectations that the cross would fall below parity), 1.10 in early May and above 1.16 in late July.

Forecast ” Markets are rightly discounting some of the more extreme and perverse scenarios, including […] surging European nationalism culminating in the collapse of the eurozone and/or European Union [..]. There is currently a tendency to over-estimate their reach and certainly their ability to dismantle the eurozone and/or EU. By end-2018, the political landscape in West Europe may not have changed as dramatically as commentators anticipate, with the traditional old guard still largely in place, including in Germany, France, Sweden and Austria […]. There are number of reasons why these nationalist parties may struggle to become the major political force.” [Black swans and white doves, 8 December 2016]

Outcome The Dutch nationalist Party for Freedom won only 20 out of 75 seats in the March 2017 parliamentary elections, well short of poll-based expectations and from being able to lead a ruling coalition. In the French presidential elections, centrist candidate Emmanuel Macron beat National Front candidate Le Pen by two votes-to-one in final round on 7 May 2017. Finally opinion polls suggest that German chancellor Merkel will win a record fourth term in the September legislative elections.

Forecast “The more likely political, financial and economic outcome from a “no” vote is perhaps less dramatic, in my view, and financial markets, including the euro, have been reasonably well behaved in the run-up to the (Italian) referendum.” [Renzi referendum frenzy – Storm in a brittle tea cup, 2 December 2016]

Outcome Euro appreciated, Italian 2, 5 and 10-year government bond yields fell and Italian banks stocks rallied in the in the wake of the Italian referendum “no” note.

Forecast “The fourth assumption, which I believe is still far-fetched, is that Front National leader Marine Le Pen could win the second round to become President, which in turn would precipitate France’s exit from the EU and pressure the euro.” [EM currencies, Fed, French elections and UK reflation “lite”, 25 November 2016]

Outcome Le Pen won only 33.1% of the second round vote – the second lowest ever percentage won by the runner-up in a French presidential candidate and below the 44% historical average.

Forecast “The rejection of the political, economic and social status-quo has lead to increasingly vocal predictions that populist and/or nationalist parties will cause major upsets at forthcoming elections in EU member states, including Italy and Austria. But forecasts that a broad-sweep of nationalist parties will rise to the highest political echelons in EU countries may still be far-fetched.” [Nationalism, French presidential elections and the euro, 18 November 2016]

Outcome The candidate of the nationalist Austrian Freedom Party, Norbert Hofer, lost a re-run of the 4 December 2016 presidential elections, despite having won the first round and come very close in the (original and later cancelled) second round.

Forecast “Immigration issue likely to further divide EU countries and fuel nationalism.” [What to expect in 2016 – same, same but worst, 19 January 2016]

Outcome Sharp rise in number of immigrants into Europe has exacerbated tensions between Germany and other EU states. Issue has fuelled growing nationalism and supported populist parties in most European countries including the UK, France, Austria and Netherlands as reflected in a number of elections and referenda.

Forecast “Open eurozone economy simply cannot afford strong euro. Expect the ECB to cut rates further and further boost QE despite Bundesbank opposition. Should keep EUR/USD well anchored, expect EUR/USD to test parity.” [What to expect in 2016 – same, same but worst, 19 January 2016]

Outcome ECB cuts its policy rates and expanded its QE program in March 2016. EUR/USD traded in a reasonably narrow range of 1.08-1.15 between 19 January and early November 2016 but weakened sharply following Trump’s presidential election victory and traded below 1.04 on 20 December and 28 December 2016.

Forecast “So the debate appears to have shifted from whether the ECB will beef up its current quantitative easing program to when. German opposition to an expanded QE program is likely to delay such a decision and the ECB’s track record suggests it would wait for clearer signs of economic deterioration before pulling the trigger.” [Deflation, what deflation?, 25 September 2015]

Outcome ECB expanded its QE program but only in March 2016.

Forecast “ECB meets on 22 January 2015 and with Eurozone inflation having turned negative and growth stalling, there is a high probability it will announce a fully-fledged bond buying program. Its immediate goal will be to cap peripheral bond yields and systemic risk ahead of Greek elections on 25 January. Ultimately it will be tasked with staving off deflation and generating jobs – a tall ask for a measure of last resort which by definition has its limitations. Its effectiveness will depend on its size – likely to be around €1 trn – and modalities but will be curtailed by its late timing. For EUR/USD it likely means further downside in coming months, in my view.” [European Central Bank QE – A little late to the party, 8 January 2015]

Outcome ECB launched €1 trn QE program on 22 January 2015. EUR/USD fell from 1.18 on 8 January 2015 to 1.06 in mid-March 2015 and Euro NEER weakened 7%.

Forecast Greek government will avoid extreme scenario of leaving eurozone and instead reach an agreement with the Troika involving new loans and modest debt relief in exchange for adhering to strict reforms (rather than a third package and/or full debt relief) [Greece – Copout still more likely than bailout or burnout; Half-time – pass me the smelling salts; Greece: Too many chefs spoil the broth?; Greece: Last chance saloon; Fifty shades of Greece; Greece Lightening — Research notes published January-July 2015]

Outcome On 13 July 2015 Greek government and lenders agreed to new loans to Greece worth around €100bn and a partial extension to the repayment schedule, in exchange for comprehensive reforms (including streamlining pension system, boosting tax revenue, liberalising labour market and privatising electricity networks).

Forecast “It feels like we’re back in 2011 again with Greek yields spiking, equities plummeting, the threat of early elections and talk of Greece potentially defaulting on its debt and ultimately exiting the eurozone. But, importantly, the EU and ECB (led by Germany) and IMF have historically shown a willingness and ability to compromise in order to “save” Greece and the eurozone. My core scenario is that this will not change in 2015″ [What to look out for and expect in 2015, 23 December 2014]

Outcome On 13 July 2015 Greek government and lenders agreed to new loans to Greece worth around €100bn and a partial extension to the repayment schedule, in exchange for comprehensive reforms (including streamlining pension system, boosting tax revenue, liberalising labour market and privatising electricity networks).