Politics and its impact on Forex market| FXStreet

Possible Scenarios and Short-Term Impact

Long-Term Impact on the EUR/USD

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. 

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.