Financial markets are relatively good at forecasting the probability of future events. The caveat is that, from time to time, the reality turns out to be something quite different.

A similar scenario played out with the euro this year – instead of breaking down to parity with the US dollar, the common currency moved up by over 10%, hitting its highest level in years. Will the markets be right this time ahead of the German election?

The euro’s turnaround

In December 2016 there was a rout against the euro. A large amount of euro/dollar (EUR/USD) futures were sold short by hedge funds and other speculators, leading to the biggest short sale ever on any global market.

Some nine months into this year, the situation looks very different. The euro hasn’t fallen to parity – or lower – against the dollar, but has stayed close to $1.20, reaching multi-year highs. The reason for this strength is the expectation that the European Central bank will soon taper its quantitative easing programme, buying less quantities of European government bonds over the course of 2018.

Protectionism and populist political parties were not the primary choice of European voters going to the polls in the Netherlands, Austria or France. European voters chose cooperation over antagonism. They voted for stronger solidarity and a common solution of upcoming problems.

The euro rose from $1.03 in January to over $1.20 in August this year – a jump of 17 cents in less than a year. This move helps to explain why some contrarian traders bet stoically against what the majority of market participants believe is right.

Surprising economic strength

This year’s eurozone elections in France, the Netherlands and Austria developed far differently to how many traders had feared it might at the start of the year. This could be positive for the German election, while the surprisingly strong economic development since the start of the year has also fostered a move away from populist parties in Europe.

The Markit PMI index has moved from a reading of around 52 in September 2016 to clear expansionary territory, hitting almost 57 in early summer 2017. Surveys ahead of the election show that voters in Germany are shunning euro-sceptic political parties like the AfD, and voting instead for parties which they think might have played the biggest role in bringing economic stability. It seems that the bounce back in approval ratings of the CDU and FDP since the start of the year can be attributed to this economic strength.

The reason a number of traders bet on a lower euro and were sceptical that the rally in the DAX could last, was based on the expectation that the European Central Bank would need much more time than the US Federal Reserve in its attempt to normalise monetary policy.

Economic growth in the US has been disappointing since the start of the year, and the Fed is keeping rates on hold while many think that the ECB is behind the curve. So we have a situation which is the clear opposite to what was expected at the beginning of the year. This helps to explain why the euro is stronger.

BU: the euro has been getting stronger


Current election trends

The current pro-European, economically optimistic trend could last until at least the German election on 24 September. Parties whose voters think they have attributed most to the economic turnaround could be the ones who will receive the most votes, when 61.5 million Germans go to the polls.

Even though there have been losses in approval ratings due to the refugee crisis, the conservative CDU/CSU union could get close to 40% of the votes. This would make it the strongest single political party in Germany, and would be just 1.5% shy of what the CDU received in the last election four years ago. It is also 16% more than what the next biggest party, the SPD, is expected to receive.

After the election debacle of 2013, the liberal FDP party is back in the picture. In some polls, the FDP received 9% of the votes, making it the party which has received the most new votes in Germany. It is also 4% more than in 2013. It therefore seems fairly certain that the FDP will be back in the Bundestag for the next four-year term.

The leftish SPD has had a rollercoaster ride over the past year, with approval ratings shooting up as much as 12% when Martin Schulz was appointed as the new party leader, before dropping back down to near multi-year lows at 23% in August. This would give the social democratic party the same vote share as four years ago.

 

Heightened market volatility is likely over the election period, which could result in widened spreads. We recommend that you monitor positions carefully, consider the use of appropriate risk management tools and maintain a sufficient account surplus throughout this period.

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