Euro's Hot Streak Could Stall Should German Coalition Talks Fail

(Bloomberg) -- The euro’s bull run may face a hiccup should Germany’s leaders fail to break a four-month political impasse that has left Europe’s largest economy without a majority government.

The common currency could fall as low as $1.17, a level not touched since mid-November, should the Social Democratic Party decide not to pursue a coalition with Chancellor Angela Merkel, according to Morgan Stanley. The SPD is holding a special convention on Sunday to decide whether to pursue formal talks with Merkel’s Christian Democratic Union-led bloc.

Any euro move fueled by the outcome of the SPD meeting would kick off what looks to be a busy week for the currency, with the European Central Bank’s first policy decision of the year due Thursday. Should the euro weaken, Toronto-Dominion Bank sees declines most pronounced against the yen.

Below is a compilation of analyst views:

Morgan Stanley

• “The risk-reward of entering euro longs at current levels is unattractive ahead of Germany’s SPD vote,” strategists including Hans-Guenter Redeker wrote in a research note
• See asymmetric risks from the SPD outcome, with a failure of the vote meaning “more downside for the euro than upside if the vote passes”
• See the euro falling as low as $1.17 on a ‘no’ vote
• An outcome that leads to expectations of increased fiscal spending or euro-zone integration could push euro higher

Toronto-Dominion Bank

• “A breakdown in coalition negotiations could see the euro come under pressure,” strategist Ned Rumpeltin says in emailed comments
  • “We don’t think we’ll be looking at a major pullback, but it looks like investors have accumulated a notable long-EUR exposure over the last week or two, suggesting near-term positioning risks are starting to build”
• Euro-yen may be the “better angle” for those positioning for a negative scenario, with the U.S. facing a potential government shutdown over the weekend as well

ABN Amro Bank NV

• If the SPD “support a grand coalition it could help euro somewhat but such outcome is more or less priced in,” Georgette Boele, a currency strategist at the bank, said in emailed comments
  • A ‘no’ vote from the SPD “could weigh on the euro”
• “We also have the possible government shutdown in the U.S. so it will be lots of politics”
• The bank’s euro-zone economist sees the SPD voting ‘yes’ to coalition talks, Boele adds

Societe Generale SA

• “The psychology until recently is to buy euro dips. This and the ECB next week will be a test if tactics must change,” strategist Kenneth Broux says, referring to the possibility of talks failing, in emailed comments
• “It’s an asymmetric risk,” he added
  • “Euro and Dax lower if the SPD votes ‘no’ to coalition talks; not much change if ‘yes’”
• The common currency could fall as low as $1.2035 if the SPD turns down the chance to enter coalition talks
• Sees the probability of either outcome as 50-50

Royal Bank of Canada

• The euro’s recent rise would suggest potential for the currency to take a hit should the SPD not agree to formal talks, according to strategist Adam Cole
  • Unlikely to fall as low as $1.17, with moves more pronounced against the yen if there is any risk-off move, he says in emailed comments
• Still, the bank is bearish on the common currency, seeing it fall to $1.12 by year-end

To contact the reporters on this story: John Ainger in London at jainger@bloomberg.net, Charlotte Ryan in London at cryan147@bloomberg.net.

To contact the editors responsible for this story: Ven Ram at vram1@bloomberg.net, Anil Varma, Neil Chatterjee

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