Euro: Political risks seen contained for now – Nomura

Nomura’s FX strategists note that recent AfD gains in German regional elections have had little impact on EUR/USD so far, as markets see them as local events with limited national implications. They argue EUR/USD remains supported by a relatively hawkish European Central Bank (ECB), softer US exceptionalism and improving Euro area portfolio flows, while acknowledging German and French politics as downside risks.

EUR downside tied to national politics

"For FX, there are only likely to be clear negative implications for EUR if the AfD’s regional success becomes more concrete at the national level, especially if early elections are called and the party looks set to become the largest in parliament."

"FX markets barely registered the news of AfD’s win over the weekend, in our view for two reasons. First, the results were only slightly different to what polling was suggesting ahead of the vote, and second, the results remain confined to local elections, with limited impact on national politics. If the AfD’s surge is matched in upcoming regional elections, however, markets may need to start paying more attention."

"For example, if Chancellor Merz was to be forced out and an early election was set to materialise then EUR could start to see some negative risk premium priced in, with AfD potentially in the running to be the largest party."

"That said, we argued in our recent note on regional politics that EUR is likely to be somewhat immune to negative political risks for now. The rise of right-wing populism retains a nationalist overtone, but for euro area nations, the threats to leave either the EU or the single currency are much less prominent than in the past."

"We remain long EUR/USD, as we see the single currency benefitting from the more hawkish reaction function of the ECB compared with other central banks, a decline in US exceptionalism, a shift in portfolio flows into the euro area and positioning remaining marginally short EUR on a broad range of measures. Of course, political factors are a downside risk to this view, not just in Germany but also in France, and to a lesser extent Italy."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)