In Dramatic Rebound, Euro, DAX Recover All Losses; “Is Strong Government Overrated?” SocGen Asks

The following excerpt is from an article that originally appeared on Zero Hedge

Having tumbled 80 pips to a one week low in kneejerk response to the late Sunday news that Angela Merkel had failed to form a government following the collapse of the “Jamaica Coalition” talks – when the Free Democratic Party walked out, saying the differences with the Green party were too great to bridge – both the Euro and European stocks have staged an impressive rebound, and the entire gap lower in the FX pair has now been, well, pared.

Alongside the rebound in the EURSD, the German DAX, which earlier fell as much as 0.5% at the open (and whose futures at one point overnight looked set for a 1% drop), trims early losses and briefly even turns positive, on what some have speculated was another round of central bank intervention.

As Bloomberg notes, while analysts contemplated possible scenarios of Merkel setting up a minority government headed by her Christian Democratic-led bloc or asking President Frank-Walter Steinmeier to order a fresh national election, “leveraged and interbank names were quick to fade the euro’s dip that stretched as much as 0.6% to 1.1722.

In other words, the CTA momentum chasers came, saw, and BTFD.

As a result, the euro briefly moved above 1.1800 to touch day high of 1.1812 as short- term names were stopped on the move above 1.1780, traders in London and Europe told Bloomberg. Meanwhile, BBG adds, option gauges – volatility term structure, smile, butterflies – pointed to a non-lasting effect of the German news, with market focus turning to speeches by ECB policy makers including Draghi, Constancio and Nowotny.

And while every analyst – who had previously been wrong about the direction in the EURUSD over 2017, had hot takes to explain why Germany is fine even if Merkel is forced to hold a new government elections, something that has never happened before – the common response boiled down to one argument: the German economy us strong enough to offset political uncertainty after government talks collapse.

In other words, when you have a central bank monetizing more than 100% of all net issuance, who needs a government. While rhetorical, this question is quite relevant, and none other than SocGen’s FX strategist Kit Juckes asked it this morning, in a slightly different version when he wondered if one even needs a government in the “new normal.” Below we excerpt from his note:

Is strong and stable government over-rated? 

After the collapse of German collation negotiations, the euro is 0.1% lower against the dollar, and 0.4% lower against this morning’s best currency, the Kiwi. That is not a dramatic reaction, but it is consistent with insouciance in European bond markets, where neither swap spreads nor peripheral yield spreads have reacted significantly yet. A break higher in EUR/USD may still require the large net long position in CFTC data to shrink, and the trend in relative yields to start moving back in the euro’s favour. It might just be that a political vacuum is no worse for Germany and the euro than it has been for, say, the Netherlands or Belgium. After all, the current UK Government’s slogan is ‘strong and stable’….

There are, I suppose, four plausible outcomes in Germany:

The first is that the Jamaica coalition is revived, which seems unlikely.

The second is that the CDU/SPD coalition is revived but that seemed to be what the electorate were unhappy with at the election.

The other two, fresh elections or the CDU ruling as a minority government, are untried in the modern era.

The only real enthusiasts for new elections are the AFD, who might build on their strong showing last time around.

Maybe what markets are saying overall is that minority  government or further coalition talks are fine, as long as the economy is growing. As for the FX conclusion, the EUR/USD 1.1480-1.1880 range is holding. If we can get positioning right and relative yield trends moving in the euro’s favour, we can break higher.

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