Politics and its impact on Forex market| FXStreet

German Coalition Decision

Trading the Italian elections and the German coalition decision

Sunday, March 4th, features two key political events in Germany and Italy. Not all the scenarios are priced in and could impact the Euro in the wake of the new week. These two important political events have the potential to shake the Euro in the wake of the new week. Positive outcomes are mostly priced in, so a move depends on adverse surprises. In case of an SPD rejection, the Euro will likely suffer regardless of the Italian elections as this will be a bigger surprise in the largest country. In case the SPD gives the green light, the risk is lower. The reaction may have to wait until the results in Italy are clear enough.

Italian Elections

Possible Scenarios and Short-Term Impact

by Yohay Elam

Long-Term Impact on the EUR/USD

by Giuseppe Basile, CSTA/IFTA

Hung parliament is not so bad, Berlusconi comeback possible

1- Hung parliament to Grand Coalition: The most likely outcome according to analysts is a hung parliament in which neither of these three blocs reaches an outright majority. In this case, the center-right and center-left parties may opt for a renewal of the Grand Coalition, again under Gentiloni. This would be the most favorable outcome for markets, as the stance would be pro-European and mostly pro-market. The euro would tick up.

Another grand coalition will not come instantly and may leave some uncertainty in the short run. Nevertheless, the current government has been comfortable for both parties, and they should be able to cobble up a coalition.

2- Berlusconi is back: Another possible outcome is an outright majority for the center-right alliance, sending Berlusconi back to power. European leaders are not big fans of the man, but markets would probably cheer a center-right, pro-business government in Italy. The euro may rise even further on the immediate certainty of having a new government.

The other options have a low probability.

3 - Renzi returns: A win for the center-left PD would represent continuity and would be favorable for the markets, but the party is in decline. The EUR/USD could tick up.

4 - 5 Star-Movement wins: The worst option for the markets and the euro would be an outright majority of the 5-Star Movement. They may be anti-business and may trigger some instability within Europe even if they do not propose leaving the euro-zone. Yet also here, the chances are remote. In this scenario, the EUR/USD would fall sharply on this extreme scenario.

Technical Review of the Euro and potential impacts

The Euro/Dollar pair, after basing for around 2 years between 2015 and early 2017, has moved higher during 2017 to challenge the first area watched by Smart Money, Program Trading and Algorithms at 1.2170. No short interest was shown by participants in that area. In the meantime Dumb Money (the crowd) is looking for a continuation of the move higher that can clearly be seen on charts.

Above 1.26 the Euro has the potential to continue higher into the 1.32 next resistance area. If fear or worry sets in the markets, after the Italian elections and/or during the negotiations for a new government – or if the M5S wins the elections, we could see a sharp market correction into the 1.1600 – 1.1900 area. If it happens, the extent of the move would also depend on whether the environment of raising interest rates in the US will be able to slow down and reverse the current move lower in the Dollar Index.

On the upside, a surprise vote bringing Berlusconi’s coalition to over 40% and short consultations for the creation of the new Italian government could push the Euro higher very quickly, in few weeks, into the 1.32 area.

In the intermediate and long-term, should the new government demonstrate inability to manage the major issues (banking system, return to growth, indications that debt is being addressed, etc.) and a new crisis affect Italy and the EU, we could see the Euro moving down to the bottom of the 2015-2017 range in the 1.05 area, or below. 

Major Players

by Giuseppe Basile, CSTA/IFTA

The center-left Democratic Party of Matteo Renzi, past prime minister who promised to dismantle the old ways of the political establishment but fell well short and stepped down in 2016 – after the failure of his reform agenda – has slipped to 20% support, down from around 40%. His signature achievement? The legislation to reform Italy’s sclerotic labor markets, hardly a vote-winner.

The center-right coalition will be led by a reborn Berlusconi, often at odds with Matteo Salvini (leader of the Northern League) – who has his own eye on the center-right leadership – and with the group’s third, smaller partner: the right-wing Fratelli D’Italia (Brothers of Italy). Berlusconi’s Forza Italia is polling around 15%, slightly higher than the Northern League’s support, but well below the party’s best at 25%. The three share a political platform and a polled 35% of votes and could win the elections.

The Five Star Movement (M5S), no longer led by founder and comedian Beppe Grillo, but with an official 31-year-old prime ministerial candidate Luigi Di Maio, continued to gain momentum. It has an estimated support of around 26-30% and has matured since its founding 8 years ago. Support at it remains popular despite its poor performance running the council of Italy’s capital, the city of Rome.

In one aspect the Italian election may be singular. 5 Star may receive enough votes so that it would almost have to be included in any coalition. Mr. Grillo has rejected that possibility, saying that unless the party wins an outright majority it should remain in opposition.

If no party or coalition wins a parliamentary majority, Italy's president may ask parties to form a cross-party coalition, but the chance of a stable government in Italy's fractious political system is remote. If that fails he could call fresh elections, but with the electorate divided and no political or economic development on hand to change the balance another ballot would be unlikely to produce anything more than a temporary result.

Whatever the outcome of Sunday's election the actual political change in Italy, as it was in Holland, France and Germany, is likely to be minimal. Markets have barely registered the election, a clear sign that nothing untoward is expected.

Europe is restive but not yet rebellious. It will take much greater political and economic upheavals to make abandonment of the euro and the EU into a winning political agenda. But that does not mean the unified future is secure. Demographics and economics are not on the continent's side. Unless Europe’s current rulers can find the will and political capital to correct current trends these recent elections will simply be the forerunners of far more dangerous and threatening politics in the future.

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