Angela Merkel has secured her fourth term as German chancellor, but politics in Europe’s largest economy is becoming more complicated. When Emmanuel Macron won the French presidency by a decisive margin over Marine Le Pen, many investors thought that this was the end of the populist tide – it now seems they were wrong. The rise of a populist, far-right alternative party in Germany is getting much attention, after securing more than 13% of the votes. Not only did the AfD secure enough seats to enter the Bundestag, the results also make them the third largest party in Germany, and this will no doubt make things more complicated for the chancellor. Merkel now should form the first three-party coalition, after the SPD decided to go into opposition; this is not likely to happen overnight. Given that the election results were expected, the impact on the euro was not very powerful. EUR/USD initially fell 60 basis points, and then recovered half of its losses. However, the noise out of Germany in the next couple of weeks will likely lead to some volatility, and probably a further correction in EUR/USD towards 1.17-1.18. I would see a significant correction as an opportunity to build long positions, based on continued improvement in the EZ economy and central banks’ conversion.
The kiwi was under even greater pressure early Monday, falling more than 1% against the USD. Although as expected, the National Party won the largest number of votes, similar to Germany's position, it is not enough to gain a majority in the parliament and this may lead to some anxiety amongst investors. Forming a coalition also will take time, and will most likely keep NZD under some pressure.
The announcement from the Federal Reserve last Wednesday, that it would begin unwinding its balance sheet and that they are keeping the option of another U.S. interest rate rise in 2017 on the table, is still encouraging buying demand for the dollar.
Fed Chair Janet Yellen is scheduled to speak on Tuesday, at the 59th National Association for Business Economics Annual Meeting, to further discuss her views on inflation, uncertainty and monetary policy. She is among many Fed speakers who will share their thoughts after a hawkish statement. Given that there were no economic or fiscal policy surprises since the Fed’s last decision, I think we will get more hawkish rhetoric. Thus, a shift in market sentiment is unlikely to occur. ECB’s Mario Draghi, BoE’s Mark Carney, and BoC’s Stephen Poloz are also set to speak on different occasions this week.
Investors will be more concerned about President Trump’s announcement in Indiana on Wednesday. There are high expectations that he will provide critical details on tax reforms. The only leaked information so far, is that the corporate tax may be lowered, from 35% to 20%. This is still higher than what Trump had hoped for, but if legislation is passed before year-end, it will still be good news for equity markets.