Political turmoil (Daily analysis 29.10.2018)

Increased fluctuations in the euro exchange rate following Angela Merkel's resignation from the CDU chairmanship. S&P lowers Italy's rating perspective but leaves creditworthiness unchanged. The zloty under pressure after reports from Germany.

The most important macro data (CET - Central European Time). Surveys of macro data are based on information from Bloomberg unless noted otherwise.

• 1:30 p.m.: Income and spending of Americans in September (estimates: increase by 0.4% m/m in both cases). PCE Inflation in the USA (estimates: 0.1% m/m and 0.2% y/y; in the core terms the same estimates 0.1% m/m and 2.0% y/y).

German politics

In our video analysis today, we pointed out that the next few days could be a bit worse for the dollar. This impression is a result of the recent falls in US Treasury bond yields and, consequently, the questioning about the rate of interest rate increases by the Federal Reserve in subsequent quarters.

Also, S&P Global Ratings has decided to maintain Italy's rating, changing only its perspective to negative. The very description of Italy's situation is pessimistic ( the threats to growth, the withdrawal from the debt reduction path, higher financing costs for banks, higher than expected by the government budget deficit and lower GDP growth). However, S&P clearly wanted to wait and decided not to change its creditworthiness before the end of the legislative process. In addition, a year ago, on the wave of reforms, it was increased, therefore, perhaps the analysts of this agency believe that some of the positive changes will still be maintained. However, if the conflict with the European Commission is not resolved and the economic parameters are worse than assumed, it can be expected that Italy's rating will be under pressure. In general, the lack of a cut in the short term is positive for the euro and, at the same time, may maintain the EUR/USD quotations.

The third issue that may support the main currency pair and, at the same time, put light pressure on the dollar, is the US Congress elections. There is a good chance that the House of Representatives will be taken over by the Democrats. Some market participants fear that this may increase political tension and, at the same time, reduce the chances of further tax cuts and stimulate GDP growth. We believe that these fears are overestimated, but this could reduce the chances of the dollar appreciating in the short term. In the long term, i.e. the next few months, in our opinion, recent events will have little effect. Thus, the economic situation in the USA will probably be good enough to maintain the current pace of monetary policy tightening, while in other key regions of the world (e.g. the eurozone) political and economic problems will be much more pronounced than in the USA. Therefore, it seems that the euro will continue to be under pressure in relation to the dollar.

The short-term scenario (halting the decline in EUR/USD), was disturbed by reports from Germany. The local elections in Hessen, where the CDU achieved a low result, contributed to Angela Merkel's resignation from running as a party leader during the December convention. This quickly led to speculation that her position as German Chancellor was also under threat. This contributed to a fall in the main currency pair to around 1.1360 during the morning trade.

The German media informs that the Chancellor will remain in office until the end of her term, which has calmed the markets a little. In addition, it is worth noting that the result in Hessen is in line with last month's polls, and at the same time the votes from the CDU and SPD have moved primarily towards the Greens (centre-left), and not towards the AFD. After all, since the last local elections in Hessen the CDU/Green coalition has been ruling, not the CDU/SPD, as in the federal government. As a result, in the base scenario, Merkel remains in office. The risk of major changes in the German government or early elections still seems to be relatively low.

Zloty is weak but stable

In the morning, there was a chance that the Polish currency may use the dollar weakness and pare some losses. However, reports from Germany disturbed this scenario and as a result, EUR/USD moved around recent highs, i.e. 4.32 level in the morning.

If the information regarding Chancellor Merkel began to give way to pro-market reports (drop in yields of the Italian debt, weaker dollar, good condition of the German market after reports of tax reductions on cars imported by China), the zloty should pare the losses and the next few days will probably be calmer for the zloty than last week.