FX Update: The German election fizzle. US yields in focus.

FX Update: The German election fizzle. US yields in focus.

Forex 4 minutes to read
John Hardy

Head of FX Strategy

Summary:  The German election offered no decisive outcome and we are now faced with the prospect of an extensive period of building a ruling coalition and a likely garbled policy mandate. Elsewhere, the issue that will increasingly seize market attention this week is the recent rise in US yields and how close the US Congress is willing to dance at the edge of a default on US debt over the debt ceiling issue, not to mention key votes on fiscal stimulus this week.


FX Trading focus: German election letdown, US yields in focus

The German election result offers no quick answers other than that the most extreme left of scenarios, one in which the SPD and Greens combine forces with the hard left Die Linke, is not mathematically possible. While many are pumping the prospects for a “stoplight” coalition in which the Reds and Greens combine forces with the liberal FDP, I am reserving judgment due to the incompatibility of the R/G demand-side climate, fiscal and wage focus contrasted with the supply-side, less EU friendly FDP. Some argue that a “Jamaica” coalition is possible as the CDU/CSU outperformed the polls by a few percent even if they still suffered an historic drop in support. For now, the uncertainty doesn’t do the Euro many favors and the euro will likely trade weaker versus the US dollar if the rising US yield focus mentioned above continues.

The focus in the US is squarely on rising yields after the decisive break last week and how the market treats treasuries this week deserves much of our attention as we have the end of the US fiscal year heaving into view on Thursday, with not even a stop-gap proposal on the table for avoiding an immediate showdown over the debt ceiling. I will cover this more in depth in coming posts, but safe to say the situation is very complicated with even experts on Congressional maneuvers at a loss as to what happens next, in part because no contingency plans were put in place. It is extremely unlikely that the situation isn’t resolved, but given the partisan political divide in the US, the risk looks high of the standoff getting very uncomfortable as in 2011 and 2013 before a solution is found, and possibly in piecemeal fashion. The Wall Street Journal even went to the trouble to post an article discussing a scenario in which the US has nominally defaulted on its debt but the Fed steps in to prevent the technical consequences of that fact playing out.  The future of fiscal stimulus is also high on the agenda as a vote meant to take place today in the House on the infrastructure bill passed by the Senate has been put off until Thursday by House Speaker Pelosi. Is that because she didn’t have the progressive Democrats on side? The same ones that have promised to kill the bill if their $3.5 trillion social- and climate bill isn’t connected with the infrastructure bill? In short, it is a critical week for signals from the US Congress.

Chart: EURUSD heavy ahead of key support.
The German election offers no quick answers save for avoiding the most left-leaning outcomes, as I describe above, and we could be in for a long, difficult process of forming a government (the consensus view) as any combination of the existing options will mean a weak mandate for change, not the more decisive outcome those looking for a more clear-cut “all-in on EU” were expecting or hoping for. This leaves the euro in a rather passive position versus other currencies and EURUSD has headed lower today, likely far more as a function in the fresh rise in US treasury yields, where the 10-year treasury benchmark broke decisively last week and is following through a bit higher today. As long US yields continue to rise (and in particular if we work back toward the cycle highs in the 10-year toward  1.75% eventually), without stronger political signals on the prospects for more fiscal outlays in Europe, the EUR is likely to remain under relative pressure, and a break of the 1.1664 range low could lead to a further sell-off toward 1.1500.

Source: Saxo Group

Table: FX Board of G10 and CNH trend evolution and strength
The JPY still dropping like a stone in momentum terms, while GBP is taking a stab at reversing (possibly due to German election and EURGBP flows?). CAD is getting a whiff of oil prices continuing to bolt higher, with NOK riding high on the same account.

Source: Bloomberg and Saxo Group

Table: FX Board Trend Scoreboard for individual pairs
EURCHF remains a bit “too low” relative to where US and EU yields have headed since late last week – watching for a rise above 1.0900 there to suggest that this pair is picking up on rising yields developments in line with JPY crosses, where three more (AUDJPY, GBPJPY, CHFJPY) are tryingto flip to the positive side today. The EURGBP attempt to flip negative will take considerable follow-through, given the very stick range.

Source: Bloomberg and Saxo Group

Upcoming Economic Calendar Highlights (all times GMT)

  • 1145 – ECB President Lagarde at EU Parliament hearing
  • 1200 – US Fed’s Evans (voter) to speak
  • 1230 – US Aug. Preliminary Durable Goods Orders
  • 1300 – US Fed’s Williams (voter) to speak
  • 1430 – US Dallas Fed Manufacturing 
  • 1500 – Bank of England Governor Bailey to speak
  • 1600 – US Fed’s Williams to speak
  • 1650 – US Fed’s Brainard (voter) to speak
  • 0130 – Australia Aug. Retail Sales
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