Why Germany's election shock is bearish for the euro

Dubai - Results would have a seismic impact on Europe's politics, foreign relations and financial markets

The German election will have a seismic impact on Europe's politics, foreign relations and financial markets. Even though Angela Merkel won a fourth term, her Christian Democratic Union performed poorly and its Bavarian ally was decimated at the polls. The far-right Alternative For Deutschland (AFD), anti-EU, neo-Nazi rabble rousers, has entered the Bundestag for the first time since the end of the Third Reich. The Social Democrats, the party of Willi Brandt and Gerhard Schroder, has gone into opposition. The Chancellor now has to cobble together a minority government with fractious coalition parties, the Free Democrats, and the Greens. Unlike France, where President Macron received two thirds of the vote in the second round in his bid to win the Élysée Palace, the German election adds to European political risk. It is now obvious that the populist threat to Europe did not end with Marine Le Pen's defeat now that the Brownshirts are back in Berlin. A pragmatic, centre-right, "convergent" Franco-German anchor to steer Europe? Dream on.
I had recommended a strategic short on the euro at 1.20 weeks before the German election. I am now even more convinced that the euro will fall to 1.14 by New Year's 2018 as the new coalition in Berlin emerges. The impact on the Old World's finances? One, the new German government will not apologise for its huge trade surplus but seek to impose fiscal austerity on France and Italy. Two, Berlin will pressure Rome and Madrid (ex-homage to Catalonia?) to resolve their systemic banking crises via risk reduction, not risk sharing in a Banking Union.
Three, Frau Nein will have to veto any grand scheme for European deposit insurance banking union or sovereign Eurobond. The German Bundestag, with 709 members and 90 odd AFD neo-Nazis makes this impossible. Four, zero prospect of a European fiscal "transfer union". Five, Berlin will overtly pressure the ECB to "normalise" monetary policy and narrow its scope for political independence. Six, the news from Berlin will have a toxic impact on both Brexit and Italian politics. Seven, a German banker will succeed Mario Draghi as the next ECB president and inflame the Greek debt crisis. Ain't no sunshine (bailout blitzkriegs?) when she's gone. Eight, it will take at least two or three months to put together the new CDU, Free Democratic, Green coalition - the Jamaica option. Germany, one-third of the EU economy will now enter a period of political paralysis. This is not good news for the euro.
The US Dollar Index can move above 95 in the next two months as the German Grand Coalition morphs into a messy CDU-Green-FDP marriage of electoral convenience. I cannot forget that the euro's 2017 low was 1.0340 and only gapped higher on April 24 amid the euphoria of the French election and a fake inflation/ECB taper scare. I cannot also forget that when the euro hit 1.20, "deep throats" in Frankfurt, Brussels and Berlin began to engage in verbal intervention.
The North Korean geopolitical crisis, Libor/Europe interest rate differentials, Trump's tax reform and the Yellen Fed's $10 billion-per-month balance sheet unwinding plan also reinforces my conviction that we will see a 38.2 per cent retracement (alas, I cannot also forget Fibonacci) of the epic 2017 euro rally. This equates to a euro target near 1.1425.
Foreign exchange is a game of six-dimensional intellectual chess that most human beings should avoid like the plague as they cannot possibly make money in such complex, volatile, leveraged markets. However, when the ducks are lined in unison, it is a license to print money for the cognoscenti who can echo the hoofbeats, of the herd.
Japanese Prime Minister Shinzo Abe will easily win the October snap election. The Democratic Party is in a mess while the Party of Hope has no real agenda. Economic growth has accelerated. The North Korean threat reinforces voter support for the nationalist LDP led by Abe. This means fiscal and monetary stimulus will continue - classic Abenomics. The two-year US Treasury note-Japanese government interest rate spread has risen to a six month high, a bearish yen omen. At 1.47 per cent, the two-year Uncle Sam note yield is the highest since 2008. My ¥112-¥113 target, outlined in this column a month ago, has now been achieved.
The writer is a global equities strategist and fund manager. He can be contacted at mateinkhalid09@gmail.com.