FEBRUARY 2017 : FOCUS: EUROPE & US. ANALYSIS ON ECONOMIC EVENTS

The question dominating the scene is if Europe will be washed over by a wave of far-right populism, leading to a stark change in the outlook for their economic policy. The upcoming elections in Netherlands and more importantly the French presidential have been contributing to the volatility of world markets. So, the point is, where all this headed is.

Over the past week, the Euro hit record low levels, dipping below 1.0500 over concerns of Marine Le Pen’s chances of victory. The effect of Francois Bayrou backing centrist Presidential candidate Emmanuel Macron shouldn’t impact the Le Pen factor greatly but brings some relief to investors. The Euro has been following a mildly volatile trajectory, and we predict that this sentiment shall last under the elections conclude. The EUR/USD only fell by -0.50% by the week’s close, recovering to 1.0600 briefly by Friday.

CHART 1: EUR/USD exchange rate evolution LTM – Sources: Bloomberg.

With the French presidential infusing a nervous sentiment in the market, the implied volatility for the euro over the next 2 months rose to 9.292 percent from around 8.6 percent on Monday. Implied volatility for the euro over three months recently approached a peak of 11.45 seen in mid-December, compared to an all-time peak of 13.06 level, owing to the Brexit.

CHART 2: EUR/USD 3-month implied volatility – Sources: Financial Times.

Over the past month, Euro Zone has shown signs of weakness. Euro Zone GDP y-o-y came in as 1.7% for the 4th quarter as against expected 1.8% and previous 1.8%. Industrial production came in as -1.6% as against -1.5% expected. The German ZEW current sentiment nosedived to 10.4 against last month’s release of 16.

At the end of February, the USD has strengthened, especially due to the news that Scotland is planning another referendum of independence from Britain, given the fact that most of Scotland were not in favour of Brexit.

Drawing the attention towards the US economy, Yellen was hawkish on raising rates during her testimony before the Congress, and the probability is around 40% of a March rate hike. Fed’s Harker, who is a voting member, said that he sees three rate hikes this year irrespective of the fiscal policy. Trump is to address a joint session of Congress on Tuesday where he is expected to disclose broad contours of tax plan and infrastructure spending proposals. An inability to do that will be bad for the dollar rally. USD held its strength the past week, despite softening PMI numbers. Both manufacturing and services PMI data were lower than expected.

Trump’s state of the union address on Tuesday will be a key event this week. The month of March is crucial for markets because March 15th is a hard deadline on the US debt ceiling extension, which automatically freezes the US debt ceiling at 20 trillion. Post the ceiling freeze, there might be a need to cut fiscal spending, rather than enhancing spending, as Trump is inclined to do. However, a key question is if Europe will be on the quest of raising rates as inflation is on the rise.

 

SOURCES:

Bloomberg, Financial Times.