Merkel weakness doesn’t faze Euro

Is Angela Merkel seeing the beginning of the end of her long run as German Chancellor? Yesterday’s vote for her party’s parliamentary head suggests as much. The Christian Union parties unexpectedly dumped Volker Kauder, a close Merkel ally, and instead elected Ralph Brinkhaus. This adds further pressure to Merkel’s leadership and boosts opposition parties (the right-wing AfD, for instance) that hope to end Merkel’s grand coalition. Still, it was not a rout – the vote was close, and the newly elected party chairman confirmed that he would be backing Merkel. All in all, it is a weak revolution within CDU/CSU coalition.

So we see no reason for German growth to slow down in the second half of 2018. Domestic demand continues to support the economy, especially services, although manufacturing is deteriorating amid US protectionism. Economic indicators are encouraging. Trading along 1.1767, EUR/USD is expected to bounce higher, heading along 1.18.

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WWTFD?

What would the Fed do – i.e. the US Federal Reserve in its monetary policy meeting that ends later today? Yesterday US consumer confidence came in at a 5-year high, driving hopes that GDP will sustain its current rate of acceleration. Domestic spending is likely to remain high, but slowing in exports will offset the optimism. Also on the downside, key goods such as cars and housing are being priced out of access to most Americans. This could slow expenditures and increase saving. The Fed’s meeting should not surprise. We expect a 0.25% rate hike now and another 0.25% in December – as already expected – and no change in policy. It would be a shock if the FOMC did not increase rates.

It appears the Fed will stay its course for a total of four hikes in 2018, three hikes in 2019 and one hike in 2020 (there are calls on the street for a hike in 2021). According to a major German bank, there is a strong Forex pattern where markets sell USD on the day of Fed decision, and then buy the USD the day after. For a short-term trade, it looks interesting.

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