There are two very important events occurring this week. However, you’d be forgiven for not knowing they were happening.
Generally, international elections tend to make headlines in Australia. Yet the German election is being held this week, and chances are you didn’t know it was on.
Germany is the largest economy in Europe, and is the most important member of the European Union, effectively keeping the EU project intact. Any policies that come out of Germany heavily affect the value of the euro.
Angela Merkel, the current German Chancellor, came to power in 2005. Already her political party, the Christian Democratic Union (CDU), is showing a 14% lead against its closest competitor, the Social Democrats (SPD), according to poll results published by the Emnid institute.
When Germans go to the polls this Sunday, 24 September, Merkel’s party is widely tipped to make history. The win would make it her fourth full term in office. Were that to happen, and Merkel serves the entire term, it would place her alongside Helmut Kohl (German Chancellor from 1982 to 1998) as the second-longest serving chancellor. Only behind the longest sitting Chancellor Otto von Bismarck, who served for almost two decades in office from 1871–1890.
Furthermore, it cements her status as the most powerful person in the EU, and will see her reign extend well into the 2020s.
A recent poll indicated that Germans are quite happy with Merkel’s leadership, showing an approval rating of 60%. Should Merkel win as expected, Germans — and the rest of the world — can expect more of the same policy-wise.
Germany is seeing record high employment, low borrowing costs and rising real wages; all of this is leading to a consumer-driven recovery in the economy. Clearly the German public is happy with this, and is likely to vote Merkel back in as a result.
What’s more, a Merkel win would be good news for the euro. Although, FXStreet reported this morning that the price of the EUR/USD cross rate already looks like it has factored in a Merkel win. Making it highly unlikely that the euro would swing wildly one way or the other. What could happen, however, is a steady increase in the EUR/USD rate from this morning’s US$1.1988.
Yet the German election isn’t the only thing affecting US dollar weakness.
As the euro maintains its strength, the long-term weakness of the US dollar is likely to remain on the back of this week’s Federal Reserve Bank Federal Open Market Committee (FOMC) meeting.
The Fed is expected to keep the cash rate on hold again this month.
So while the US dollar may bounce along in response to the news, it’s highly unlikely that it’s about to stage a sudden rally.
If anything, once news filters through that the Fed hasn’t increased rates, as I expect, the US dollar may fall even further.
What should cause short-term volatility however is anything that comes from the mouth of Fed chairwoman Janet Yellen.
Chances are the Fed will switch tack to what’s called ‘forward guidance’. That is, rather than raise rates, they’ll use certain language to suggest that a rate rise can be expected, but then reiterate that a rate rise will come when it’s appropriate.
From the September meeting, there’s the expectation that the Fed will share details on how it will start reducing its US$4.5 trillion (AU$5.6 trillion) portfolio of US government securities. This built up to support the US economy in the wake of the financial crisis.
In any case, if Yellen hints at a rate rise at the December 2017 meeting, chances are the US dollar will bounce higher.
What comes out of today’s meeting is most likely the long-term view the Fed puts forward. If the Fed makes noise about raising rates in 2018 and says it will start reducing their exposure to US government securities quicker than expected, that would be very bullish for the US dollar.
In saying that, some investment firms aren’t really sold on what the Fed will say this week. If anything, the Fed is stuck between a rock and hard place.
As Kathy Lien, managing director of foreign exchange strategy BK Asset Management, told CNBC this week: ‘Unfortunately, there’s not much in the way of guidance that [Yellen] can provide, because the Federal Reserve themselves are kind of confused and uncertain about when to raise interest rates, and where the US economy is headed.’
Chances are, the Fed will provide no real market direction.
For currency traders, that means the US dollar should remain weak, keeping the euro higher for the rest of the year.
Editor, Markets & Money
PS: Commodities are beneficiaries of a weak US dollar. As crude oil is priced in US dollars, a weak greenback generally shows up in higher oil prices. Sustained long-term weakness in the US dollar is likely to push oil prices higher. However, Greg Canavan, editor of Crisis & Opportunity, says this and the broader bearish attitude towards oil and energy related stocks is a good thing. According to Greg, there are some exciting opportunities ahead for investors willing to look past the media headlines and delve into what’s really going to push the oil price higher. Details here.