EUR Higher Ahead of German Elections and Brexit Negotiations

Dollar weaker against EUR and GBP

The news that the United Kingdom is considering paying 20 billion euros to retain single market access post Brexit caused the euro and the British pound to appreciate versus the US dollar. The greenback had surged after the economic projections from the September Federal Open Market Committee (FOMC) meeting signalled a possible US rate hike in December. British Prime Minister Theresa May will deliver a speech on Brexit on Friday and German elections on Sunday will keep market watchers following the results.

Theresa May will deliver her first major Brexit speech since January on Friday, September 22 in Florence. A lot has changed since then with the UK leader’s snap election gamble a disaster and the Brexit negotiations deadlocked. The news that Britain is conceding a “soft Brexit” by paying into the single market follows the angry comments from one of Brexit’s main architects Boris Johnson that he would resign if May opts for a “Swiss-style” Brexit.

Germany is expected to reelect Angela Merkel’s party the Christian Democratic Union (CDU) during the Sunday, September 24 election. The main question still unanswered is who will make up the coalition needed to form a government. The Social Democratic Party (SPD) is anticipated to come in second, but is said to want to avoid a repeat of the current grand coalition. Germany has not proven immune to the rise of populism with the rise of the Alternative for Germany (AfD), the far-right party is expected to grab as much as 10 percent of the vote. The party formed in 2013 has gained support by preaching an anti-immigrant message and is could end up being the third largest party and in some scenarios could be the opposition to Merkel’s CDU led grand coalition. Exit polls will be quick to announce the results, but the coalition forming process could last weeks but knowing the allocation of the votes will be instrumental in adding stability to the market.

The EUR/USD gained 0.488 percent in the last 24 hours. The single pair is trading at 1.1935 on Thursday as the US dollar was hanging on from gains after the Fed posted hawkish rate projections as part of its Federal Open Market Committee (FOMC) meeting this week but had to depreciate following the rise of the EUR on the news of a softer Brexit gaining traction.

The positive impact the Fed’s hawkish projections has started to fade as a potential Brexit turning point is on the horizon which could break the deadlock and advance negotiations to a less harsh break up between the UK and Europe.

The U.S. Federal Reserve published its updated economic projections and as expected kept the interest rate unchanged at 100–125 basis points. Also keeping with market forecasts the US central bank announced it will start the reduction of its balance sheet in October. The start date was the only piece missing as the Fed has already outlined the process it would follow. The biggest factor in the Fed’s FOMC meeting was the number of members that still see a rate hike in 2017. 11 out of 16 officials still see the appropriate level for this year at 125 to 150 basis points.

The Fed has raised rates at the December Federal Open Market Committee (FOMC) meeting in the past two years and could do so at the final meeting of the year. The central bank has supported the dollar with 2 rate hikes in 2017 so far, and is now shedding its massive balance sheet. The portfolio of bonds that were accumulated as part of the stimulus program will shrink by $10 billion each month.

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Alfonso Esparza

Alfonso Esparza

Senior Currency Analyst at Market Pulse
Alfonso Esparza specializes in macro forex strategies for North American and major currency pairs. Upon joining OANDA in 2007, Alfonso Esparza established the MarketPulseFX blog and he has since written extensively about central banks and global economic and political trends. Alfonso has also worked as a professional currency trader focused on North America and emerging markets. He has been published by The MarketWatch, Reuters, the Wall Street Journal and The Globe and Mail, and he also appears regularly as a guest commentator on networks including Bloomberg and BNN. He holds a finance degree from the Monterrey Institute of Technology and Higher Education (ITESM) and an MBA with a specialization on financial engineering and marketing from the University of Toronto.
Alfonso Esparza