FX Strategy: Who’s afraid of European Parliament elections?

• UK voters to punish main parties

• Italian populism

• Euroscepticism on the march

Voters in the European Union (including Britain) will elect MEPs between May 23rd and May 26th. The results of this could push the European project in a new, uncertain, direction, which may well be felt in the markets via the euro and bond prices. Meanwhile a shakeup in the UK electoral landscape may have repercussions for the Brexit process and therefore impact the pound.

GBP: Ain't no party like a Brexit party

This is an election that no one wants to be part of. Campaigning by the main parties has been lacklustre and UK voters will certainly punish both the Conservatives and Labour. Polls indicate support for the new Brexit Party under Nigel Farage. The Liberal Democrats - on an overtly anti-Brexit ticket – are also performing well.

Latest YouGov polling suggests Brexit Party in a clear lead on 35%, with the Lib Dems behind on 16% and Labour on 15%. A 10% print for the Greens put them fourth and the Conservative getting a kicking in fifth with 9%.

So where does this leave us? The result will not change the Westminster arithmetic at all. But if current polling is accurate, it would send a powerful signal to the government and opposition that the public is sick of the Brexit process. This matters more for the ruling Conservative party and could expedite the departure of Theresa May – certainly a heavy defeat would reduce the chances that she tries to cling on beyond the summer, albeit this cannot yet be ruled out.

Indeed, somewhat counter-intuitively, a major defeat for the Conservatives might just force some of hold-outs among MPs to back Mrs May's deal. But this seems more a hope rather than expectation. As noted on many previous occasions, it seems a dead cert that Mrs May's deal simply cannot pass and she is almost certain to be gone by June.

Whilst European Elections are by no means the largest determinant for the pound, the spectre is adding to the downbeat mood around sterling.

GBPUSD has slipped its 1.28 handle and is finding bid hard to come by. At time of writing, on the downside we see 1.2710 and 1.2670 as representing the next main levels of support. Momentum indicators suggest the pound is borderline oversold, but by no means heavily oversold. But with the pound close to its YTD lows and looking at past performance, range traders may consider this as a potential dip-buying opportunity. Monday's candle formation suggests an emerging three inside up bullish reversal but we would need to see this confirmed by a big push higher on Tuesday out of Friday's high and a close above 1.28.

EUR: Italian populism

Of course, the euro is also going to be susceptible to the outcome from the European elections. Adding to the potential volatility, we have the ECB and FOMC meeting minutes due to be released this week as well. Furthermore, flash PMIs are due on Thursday, which are predicted to show that the Eurozone slowdown is in a trough that is proving far more difficult to get out of than many, including the ECB, thought.

There will be a particular focus on the ruling Italian populist parties. A strong showing for Lega Nord would strengthen their position in Rome and could lead to more confrontation with Brussels – they seem more at odds with the European establishment than Five Star, who were first in last year's national election. In particular, we could see further budget battles, rising Italian yields and a widening in the bund-BTPs spread that would be considered negative for the euro.

Lega leader and deputy prime minister Mattteo Salvini has been forthright in calling for Italy to break EU fiscal rules. Whilst this may be considered as electioneering to appeal to his base – and was criticised by his Five Star coalition partner Di Maio, who described as ‘irresponsible' any comments that stoked Italian yields – there is a risk premium to be applied. To be highly reductive, the better Lega does the more likely we see a bearish outcome for EUR.

Euroscepticism on the march

It's not just Italy – Euroscepticism is on the march across the continent. The size of right-wing and Eurosceptic blocs after the elections will also be of great importance. A gathering in Milan over the weekend highlighted that the disparate parties may be able to work together as they seek to rip up the European order. Polls indicate populists could claim as much as a third of the vote. With new found organisation, some of these parties are set to form a new bloc in parliament, the European Alliance of Peoples and Nations, led by Italy's Matteo Salvini.

Whilst a grouping of parties with such diverse national interests would of course be hard to whip, it would nonetheless put pressure on the pro-European status quo. Whilst the EPP (centre right) and S&D (centre left) blocs are still set to win the most seats, it looks certain they will fall short of a combined majority. This would mark an important shift in European politics. The rise of the Eurosceptic wing in the EP will undoubtedly have an impact on the executive and choice of EC president to replace Jean Claude Juncker. However, a strong showing by the Greens would tip the scales back in favour of the moderates and against the Eurosceptics.

We should also pay close attention to France, where the far-right ENF bloc is polling very well – this would likely put further pressure on Emmanuel Macron's economic reforms.

EURUSD has continued to show weakness and remains in a downward trend. Macroeconomic factors and expectations of further easing by the ECB have been the major drivers for this weakness. However, we have seen repeatedly in recent years how political uncertainty surrounding the rise of populism has stoked volatility in EUR crosses.

Charts

GBPUSD

 

 

EURUSD