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A note on lower timeframe confirming price action...

Waiting for lower timeframe confirmation is our main tool to confirm strength within higher timeframe zones, and has really been the key to our trading success. It takes a little time to understand the subtle nuances, however, as each trade is never the same, but once you master the rhythm so to speak, you will be saved from countless unnecessary losing trades. The following is a list of what we look for:

• A break/retest of supply or demand dependent on which way you're trading.
• A trendline break/retest.
• Buying/selling tails ... essentially we look for a cluster of very obvious spikes off of lower timeframe support and resistance levels within the higher timeframe zone.
• Candlestick patterns. We tend to only stick with pin bars and engulfing bars as these have proven to be the most effective.

We typically search for lower-timeframe confirmation between the M15 and H1 timeframes, since most of our higher-timeframe areas begin with the H4. Stops are usually placed 1-3 pips beyond confirming structures.

EUR/USD

Despite a strong bounce materializing from the 1.19 handle in opening trade on Monday, the single currency remained under pressure from the results of the German elections. After H4 price conquered the 1.19 support in early London the unit aggressively tumbled lower, consequently ending the day bottoming just ahead of August's opening level at 1.1830. Also noteworthy here is the H4 AB=CD symmetry denoted by the black arrows, the nearby daily demand zone pegged at 1.1739-1.1823 and current weekly support marked at 1.1871.

Suggestions: On the whole, we do believe the EUR is likely headed higher. Not only because of the clear technical support in place, but also due to the strong uptrend the major has been in since the beginning of the year. However, before this we may see the pair surpass August's opening level to test the top edge of the noted daily demand base (between the H4 AB=CD 127.2% mark at 1.1815 and the 1.18 handle looks a nice reversal point [green zone]).

Should price challenge the green H4 buy zone today and chalk up a reasonably sized H4 bull candle, preferably in the shape of a full, or near-full-bodied candle, the odds of price rallying back up to 1.1850/1.19 are high, in our view.

Data points to consider: US CB Consumer confidence along with New home sales at 3pm; FOMC member Brainard speaks at 3.30pm, followed by Fed Chair Yellen at 5.45pm GMT+1.

Levels to watch/live orders:

• Buys: 1.18/1.1815 ([waiting for a reasonably sized H4 bullish candle to form – preferably a full, or near-full-bodied candle – is advised] stop loss: ideally beyond the candle's tail).
• Sells: Flat (stop loss: N/A).

GBP/USD

Sizing up the weekly chart this morning, we can see that the candles remain trading between a major resistance coming in at 1.3683 and a broken Quasimodo line at 1.3371/channel resistance-turned support extended from the high 1.2706.

On the H4 timeframe, recent events show the 1.35 handle was taken out amid yesterday's US open, forcing price to clock a session low of 1.3431. In a similar fashion to the EUR/USD, the GBP has also chalked up a reasonably nice-looking AB=CD bullish structure (black arrows). From this angle, it'd be difficult to rule out the possibility of an upside attempt to retest 1.35 today, but we feel that the unit may want the H4 demand base seen below at 1.3381-1.3405 before serious buyers step in. Not only does the area converge with the AB=CD's 127.2% extension at 1.3413, it has a round number lodged within at 1.34 and sits directly above the noted broken weekly Quasimodo line.

Suggestions: Put simply, we will not be looking to long this market UNTILL H4 price has shook hands with the aforesaid H4 demand. A word of caution though, there is a strong possibility that this area may suffer a fakeout given the weekly support lurking just below it. For that reason, we would advise waiting for additional H4 candle confirmation before pulling the trigger.

Data points to consider: US CB Consumer confidence along with New home sales at 3pm; FOMC member Brainard speaks at 3.30pm, followed by Fed Chair Yellen at 5.45pm GMT+1.

Levels to watch/live orders:

• Buys: 1.3381-1.3405 ([waiting for a reasonably sized H4 bullish candle to form – preferably a full, or near-full-bodied candle – is advised] stop loss: ideally beyond the candle's tail).
• Sells: Flat (stop loss: N/A).

AUD/USD

Working our way down from the top this morning, the commodity currency clearly remains under pressure, which could force the unit in the direction of a support area carved from 0.7849-0.7752. Meanwhile, daily action shows the recently engulfed support at 0.7955 is holding ground as resistance. Provided that the bears continue to defend this line, daily demand at 0.7786-0.7838 is likely going to be the next port of call on this scale (seen plotted within the walls of the noted weekly support area).

The story on the H4 timeframe, nevertheless, is somewhat restricted. In recent trading, the candles breached September's opening level at 0.7939 and potentially opened up the river south down to nearby Quasimodo support at 0.7917, shadowed closely by the 0.79 handle.

Suggestions: Although both weekly and daily charts indicate further selling may be on the cards, shorting H4 price is risky according to structure. Just 22 pips down from September's opening level is the first area of concern (the H4 Quasimodo). Therefore, it would take an incredibly small stop to accommodate suitable risk/reward here! For this reason, our desk will refrain from taking any short positions at this time.

Data points to consider: US CB Consumer confidence along with New home sales at 3pm; FOMC member Brainard speaks at 3.30pm, followed by Fed Chair Yellen at 5.45pm GMT+1.

Levels to watch/live orders:

• Buys: Flat (stop loss: N/A).
• Sells: Flat (stop loss: N/A).

USD/JPY

As can be seen from the H4 chart this morning, the USD/JPY stabilized around the mid-way support 111.50 (fuses with AB=CD bullish structure taken from the high 112.71 [black arrows]) after aggressively storming through the 112 handle.

Over on the bigger picture, weekly flow continues to reflect a bullish stance. In the event that this remains the case, the next upside target can be seen at a supply area drawn from 115.50-113.85. Conversely, however, the daily candles recently crossed below support at 111.91 and show potential to move down as far as support pegged at 110.76.

Suggestions: Entering long is a tricky beast right now. As of current price, we have only 25 pips of space to extend north until we collide with 112, followed closely by July's opening level at 112.09. In addition to this, daily price portends further selling, while weekly price shows that further upside may be on the horizon.

On account of the above notes, there is not really much to hang our hat on at the moment and we feel it is best we remain on the sidelines for the time being.

Data points to consider: US CB Consumer confidence along with New home sales at 3pm; FOMC member Brainard speaks at 3.30pm, followed by Fed Chair Yellen at 5.45pm GMT+1.

Levels to watch/live orders:

• Buys: Flat (stop loss: N/A).
• Sells: Flat (stop loss: N/A).

USD/CAD:  

The USD/CAD, as you can see, switched tracks in early US trading yesterday. Offers at the H4 mid-level resistance 1.2350 were engulfed, allowing price to challenge H4 supply at 1.2415-1.2379 which fuses with the 1.24 handle, despite a rally in oil prices. Also of particular interest should be the fact that both of these areas are sited within a daily resistance area pegged at 1.2303-1.2423.

Be that as it may, before we all get too excited and punch the sell button, it might be worth noting that weekly price shows room to extend above the daily area to a long-term weekly trendline resistance extended from the low 0.9633.

Suggestions: Given the threat of further upside on the weekly scale, the team remains reluctant to sell at current prices. An area we would be interested in selling, however, is the H4 supply seen at 1.2491-1.2461. Not only is it surrounded by both September/August's opening levels at 1.2497/1.2481 and the 1.25 handle, it also intersects nicely with the noted weekly trendline resistance.

As H4 price could potentially fake above 1.2491-1.2461 to attack offers at 1.25, we would advise waiting for a reasonably sized H4 bear candle to take shape from here (preferably a full, or near-full-bodied candle), before pulling the trigger.

Data points to consider: US CB Consumer confidence along with New home sales at 3pm; FOMC member Brainard speaks at 3.30pm, followed by Fed Chair Yellen at 5.45pm GMT+1

Levels to watch/live orders:

• Buys: Flat (stop loss: N/A).
• Sells: 1.2491-1.2461 area ([waiting for a reasonably sized H4 bearish candle to form – preferably a full, or near-full-bodied candle – is advised] stop loss: ideally beyond the candle's wick).

USD/CHF:  

The value of the USD/CHF weakened in aggressive fashion on Monday after tapping a session high of 0.9745. Running through bids at the 0.97 handle and August's opening level at 0.9672, the safe-haven pair was able to conclude the day shaking hands with a H4 support area at 0.9647-0.9633.

Although there were various fundamental drivers behind this latest move, the technicals likely had their part to play as well! Weekly price came within striking distance of connecting with a trendline resistance taken from the low 0.9257. Alongside this, we can also see that daily price is trading from a resistance area pegged at 0.9770/0.9726 and shows room to decline down to at least demand located at 0.9565-0.9611.

Suggestions: While the higher timeframe's bias clearly points south right now, selling into the current H4 support area is not something we'd label as a high-probability move. Typically, what we would do in this case is wait for a H4 close to form beyond the current H4 support area and then look to trade any retest seen thereafter. Unfortunately, this is not possible here since not only do we have the top edge of the noted daily demand positioned at 0.9611 to contend with, we also have the 0.96 handle and September/July's opening levels at 0.9595/0.9580 seen nearby as well.

Data points to consider: US CB Consumer confidence along with New home sales at 3pm; FOMC member Brainard speaks at 3.30pm, followed by Fed Chair Yellen at 5.45pm GMT+1.

Levels to watch/live orders:

• Buys: Flat (stop loss: N/A).
• Sells: Flat (stop loss: N/A).

DOW 30:  

Trade update: stopped out for a loss at 22279.

During the course of yesterday's segment, US equities breached H4 demand at 22286-22323 and went on to challenge the H4 demand seen beneath it at 22187-22221. As you can see, the bounce from this area was strong enough to rotate the market back up to the recently broken H4 demand, which is now acting as resistance. Should H4 bulls overcome the current resistance area, nonetheless, the next port of call will likely be the minor Quasimodo resistance planted at 22366.

The key thing to remember here is this market remains entrenched within a strong uptrend, and is trading from record highs as we write i.e. there is absolutely no resistance seen on the higher timeframes!

Suggestions: A decisive H4 push above the aforesaid H4 Quasimodo resistance is, in our opinion, a strong indication that the bulls are ready to press to fresh record highs. And this is something we want to be a part of! Therefore, what we're looking for is a H4 close beyond 22366, followed by a retest and a reasonably strong H4 bull candle in the shape of a full, or near-full-bodied candle.

Data points to consider: US CB Consumer confidence along with New home sales at 3pm; FOMC member Brainard speaks at 3.30pm, followed by Fed Chair Yellen at 5.45pm GMT+1.

Levels to watch/live orders:

• Buys: Watch for H4 price to close beyond 22366 and then look to trade any retest seen thereafter ([waiting for a H4 bullish rotation candle to form following the retest is advised] stop loss: ideally beyond the candle's tail).
• Sells: Flat (stop loss: N/A).

GOLD  

Eyeballing the weekly timeframe this morning, it's clear to see that the bulls are beginning to show signs of a recovery from support penciled in at 1295.4. Assuming that the market continues to bid higher from here, the next area of interest can be seen at 1337.3: a resistance level. In conjunction with weekly flow, daily price extended Friday's bounce from demand at 1275.3-1291.2 on Monday and ended the day marginally closing beyond resistance at 1308.4 (now acting support).

Sliding across to the H4 timeframe, nevertheless, things do not look quite as bullish as the bigger picture does right now. In current view, we have a strong-looking H4 supply zone at 1316.1-1311.3 in play, followed closely by September's opening level at 1320.4. From our perspective, it will only be once these two H4 hurdles are consumed will the yellow metal be free to rally north up to a resistance area plugged at 1334.7-1331.8.

Suggestions: Keeping it Simple Simon this morning, we're going to wait and see if H4 price can print a decisive close above both the current supply and September's opening level. After this, and assuming that price retests 1320.4 as support, we would consider entering long and targeting 1334.7-1331.8.

Levels to watch/live orders:

• Buys: Watch for H4 price to close above 1320.4 and then look to trade any retest seen thereafter ([waiting for a H4 bullish candle to form following the retest is advised] stop loss: ideally beyond the candle's tail).
• Sells: Flat (stop loss: N/A).

STOCKS

Overall the indices are in an uptrend but could face some consolidation or correction in the coming sessions.

Dow (22296.09, -0.24%) moved back from levels near 22200 yesterday but could again try to test 22200-22100 levels in the near term.

Dax (12594.81, +0.02%) has faced rejection in the last 2-sessions from 12650 and while the resistance near 12675-12650 levels holds, Dax could be headed lower towards 12500 in the coming sessions.

Nikkei (20382.53, -0.07%) is trying to rise from levels near 20300 and the index would try to attempt to break above 20500. As mentioned earlier, 20800-20700 would be the upside limit for Nikkei in the medium term. For now, sideways consolidation within 20200-20500 region is possible.

Shanghai (3340.91, -0.02%) could test 3300 in the next couple of sessions before pausing. Only on a break below 3300, do we look at 3250-3200 levels; else a bounce from 3300 could also be expected.

Nifty (9872.60, -0.92%) has 21-week MA support near 9770 and while that holds, a slight bounce in the index is possible in the next few days. But in case the index breaks below 9770, the fall could extend to much lower levels of 9700-9600 in the near term.

COMMODITIES

Market expects extension of output cuts by crude oil producers which could fuel in improvement in demand in the near term. Some expectations of continuation of the bear market seem to be negated just now while there could be more room on the upside for the oi prices to rise. News states a fall in the global inventory levels and a possibility of a potential squeeze in oil supply if the Kurdish crude flows are disrupted after the regions independence vote.

Brent (59.33) and WTI (52.24) have both shot up in the last 2-sessions breaking above our expected levels of 57.50 and 51.00 respectively. While the upside momentum continues, Brent could move up towards 62 while WTI may rise towards 52.75 or even higher in the near term.

Brent-WTI spread (7.12) could test decent resistance near 8 and could come off slightly from there.

Gold (1310.54) and Silver (17.19) are also up sharply and while the US Dollar continues to remain below 92.70, Gold could rise towards 1320 in the next few sessions.

Copper (2.9545) could trade within the broad 3.05-2.90 region for the coming sessions. While an attempt towards 3.00 is possible, a fall to 2.90 or lower is also possible in the near term.

FOREX

Fresh tensions between North Korea and USA is threatening to break the uptrend in the Euro (1.1860) and the downtrend in the Dollar Index (92.575). It has also pushed Dollar-Yen (111.64) lower.

The support at 1.1890 mentioned yesterday on the Euro has already been broken and further dip to 1.1800 is imminent. Deeper decline towards 1.1750-10 would be triggered if 1.1800 is broken. The Dollar Index can rise further towards 93, but may not break above that easily.

Contrary to expectation of rise towards 113.50, Dollar-Yen (111.64) has fallen breaking below 112.00. Looks indeterminate now and may range sideways between 110.50-113.00 for some days. The Euro-Yen (132.35) may now dip towards 131, negating an immediate rise towards the 136 target mentioned yesterday.

Dollar strength has weakened the Pound (1.3481) a bit, bringing the projected rally to 1.38 into question. Beware of further decline if immediate Supports at 1.3430-00 breaks.

Suspicion is increasing regarding the Aussie's (0.7943) strength. But, we will give it the benefit of doubt while the mentioned Support at 0.79 holds. Let us see how it fares this week. Perhaps the uptick in Gold (1310) may help it a bit.

Dollar-Yuan (6.6209) has risen well past 6.61 and may move up to 6.65 also over time. Dollar-Rupee (65.1050) bounced well from above 64.70 yesterday and is likely to see 65.25, possibly higher, today.

INTEREST RATES

Good dip in US yields overnight, probably as reaction to the fresh North Korea/ USA tensions, as money seeks "safe havens". The US 5Yr (1.83%), 10Yr (2.22%) and 30yr (2.76%) are all down 3-4 bp and further rise this week is unlikely as the Resistances mentioned yesterday are likely to hold. The Yield Curve has steepened a bit with the 30-5 (0.93%) and 30-10 (0.55%) moving up from 0.89% and 0.50% respectively yesterday.

German 10yr (0.40%) and UK 10Yr (1.33%) have also dipped as the market turns a little risk averse.

The German-US 10yr Spread (-1.82%) had dipped below -1.85% also yesterday. It has bounced a little bit today but we note emerging weakness in the German-US 2Yr Spread (-2.14%) which could be breaking horizontal Support near current levels. This would undermine the Euro further.

The GBP/JPY drops further and corrects after the amazing rally. We had a false breakout above the 151.66 static resistance and now should hit the 150% Fibonacci line (ascending dotted line). A valid breakdown below the 150% level will confirm a drop towards the confluence area formed by the warning first warning lines (WL1).

The Gold rallied and resumed the Friday's rally. Is challenging the first warning line (WL1) of the major descending pitchfork, a valid breakout will attract more buyers. However, a rejection will send the rate towards the first warning line (WL1) of the major ascending pitchfork. It could drop again on the short term if the dollar index will stabilize above the 92.49 static resistance.

The currency pair has dropped in the start of the week and resumes the Friday's bearish candle. USD failed to hold the pair higher even if the dollar index has managed to climb higher. The minor retreat is natural after the rejection from an important confluence area, we'll see what will happen because has reached an important horizontal support.

Price continues to move in range on the short term, but I really hope that we'll have a clear direction very soon because cannot move sideways forever.

The Yen increases as the Nikkei stock index has found strong resistance and now slips lower. The JP225 was expected to drop a little after the amazing rally, I've said in the previous reports that the index should drop to retest the 20058 static support (resistance turned into support).

Technically, the JP225 is expected to climb much higher in the upcoming period after the breakout above the 20320 former high despite a minor drop.

Price failed to take out the resistance from the confluence area formed at the intersection between the first warning line (wl1) of the ascending pitchfork with the median line (ml) of the blue ascending pitchfork.

Now is pressuring the 38.2% retracement level, a valid breakdown will confirm a further drop towards the WL3 and towards the 250% Fibonacci line.

Last week's AUD/NZD cut and reverse played out nicely and with this little Aussie rally to open the week, I wanted to highlight an opportunity to get in if you missed the boat the first time around.

Click the link in the opening paragraph and take a look at the original setup, but it's all about the following daily support/resistance zone:

AUD/NZD Daily:

The significance of the zone is pretty straightforward, but I've marked the swing swing high top that I'm using just to make it clear.

You can see that after failing to hold above the zone, price dropped through. But now that price has rallied back into the zone to start the week, could this be the final retest before the pair really rolls over?

Now zoom into the hourly chart:

AUD/NZD Hourly:

I've marked the same level that we were shorting in the blog I linked to above and as you can see, price is back retesting the level again.

As long as price is below this level (which is the middle of the daily zone acting as resistance anyway), then shorts are still in play.

If this level does hold, I expect some nice momentum to come into the market and really push us lower.

The Canadian dollar depreciated on Monday hit by rising risk aversion as geopolitical events around the world dominated headlines. The German elections over the weekend showed that not even the largest member of the European Union is immune to the rise of eurozone opposition within its borders. The situation in North Korea continues to be elevated as Donald Trump’s tweets were called a declaration of war by the asian nation Foreign Minister.

Japanese Prime Minister Shinzo Abe has called a snap election of the lower house. Rising support as the result of the situation in North Korea has emboldened Abe to call for elections in October. The move is intended to weaken opponents, but like in the United Kingdom the move is a gamble that can backfire with a new national party offering the biggest threat. His major objective seems to be achieving a majority with the aim of reforming the constitution.

Oil is higher at the beginning of the week after the independence referendum vote in Northern Iraq could lead to disruptions in the oil rich area. The vote was not agreed to with the central Iraqi government and has drawn criticisms and threats of pipeline closures from other nations.

Trade representatives for Canada, Mexico and the United States are in Ottawa for the third round of talks of NAFTA renegotiation. Canadian negotiators have spoken out about the lack of details from the US team and despite good progress so far it is hard to predict when or how the talks will end.

The USD/CAD rose 0.205 percent on Monday. The currency pair is trading at 1.2364 as geopolitical risks are driving the market. Safe havens have been the biggest movers in the market. The potential disruption of Iraqi supply has put oil prices higher, but offered no support to the loonie.

This week will have few economic data points for CAD traders. Bank of Canada (BoC) governor Stephen Poloz will make his first appearance since the surprise September rate hike took the benchmark rate to 1.00 percent. The central bank was quiet ahead of announcing the monetary policy decision in stark contrast with the July meeting when it gave the market a clear heads up on its intentions. The market was expecting the 25 basis points rate hike to come in October, but the BoC thought it best to do it sooner rather than later with no warning. Poloz’s speech will be filled with the bank’s assessment of the economy that prompted the BoC to make that decision.

Later in the week the monthly GDP figures will be announced which could validate Mr Poloz’s eagerness to hike. A slowdown in growth could also raise question marks about his decision given that as expected the European Central Bank (ECB) and the U.S. Federal Reserve did not touch their benchmark rates. The Fed did finally announce the details of its balance sheet reduction program. December will be once again host the most important meetings of the year for most central banks. The Fed could hike a third time, but it all depends on the economic performance in the third quarter.

Energy in the US rose by 3.029 in the last 24 hours. The price of West Texas Intermediate is trading at $51.73 due to comments about a rebalancing of the market after the production cut agreement between the Organization of the Petroleum Exporting Countries (OPEC) and other major producers. The situation in Iraq, where an independence referendum took place on Monday. Iraqi Kurds are voting against the wishes of the central government and other nations. Turkey is on alert and has threatened to cut the pipeline taking Northen Iraqi oil to market.

Market events to watch this week:

Tuesday, September 26
10:00am USD CB Consumer Confidence

Wednesday, September 27
8:30am USD Core Durable Goods Orders m/m
10:30am USD Crude Oil Inventories
4:00pm NZD Official Cash Rate
4:00pm NZD RBNZ Rate Statement

Thursday, September 28
8:30am USD Final GDP q/q
8:30am USD Unemployment Claims

Friday, September 29
4:30am GBP Current Account
8:30am CAD GDP m/m

North Korea called Trump's recent comments a "declaration of war" and vowed to respond as the rhetoric ramps up. The US replied that Trump's comments were not a declaration of war. The Japanese yen was the top performer, closely followed by gold,while the New Zealand dollar lagged. The BOJ minutes are due later. Watch out for Yellen's Tuesday speech on inflation and monetary policy at 14:45 Eastern (19:45 London time).

The words 'North Korea' and 'war' set off algos Monday and a wave of selling in yen crosses. USD/JPY fell as low as 111.48 from 112.15. The Swiss franc and gold also jumped on the headlines and didn't retrace.

The problem with the North Korea story lately is that there is no ebb and flow. You would expect some rhetoric and then something to cool it off but neither side seems capable of diffusing tensions. Instead, the series of insults and threats continues. The comments echoed especially loudly as they emerged during US market hours. North Korea's foreign minister spoke early in New York trade and that meant extra attention in markets. Previously, the main rhetoric was limited to the weekend. Inevitably, the talk will cool down but it's tough to fade the trend at the moment against the risk of a tweet or statement at any moment.

Politics Galore

Separately, politics are dominating markets. Merkel's disappointing election showing and the risk of fractured or failed coalitions in Germany hurt the euro. US Congress is haggling over a healthcare proposal that seems dead and a tax proposal that's still unclear. In Japan, the snap election raises new risks. Brexit is never ending. It's a veritable minefield with tape bombs landing constantly and the threat of real bombs. That makes a good argument for paring risk until there is more clarity.

Coming up in Asia-Pacific trading, the minutes of the July 19-20 BOJ meeting will be released but the yen is more-likely to driven by comments from Abe and developments in North Korea.

Gold has started the trading week with gains, pushing above the $1300 level. In North American trade, the spot price for an ounce of gold is $1308.47, up 0.92%. There are no US economic releases on the schedule, but FOMC member William Dudley spoke earlier, and we'll also hear from Charles Evans and Neel Kashkari. On Tuesday, the US releases CB Consumer Confidence and New Home Sales. Federal Reserve Chair Janet Yellen will speak at an event in Cleveland.

Federal Reserve policymakers have been divided over a rate hike in December, which would mark a third rate increase in 2017. With no clear message from the Fed, the markets really don't know what to expect, and fed futures have priced in a December hike at 55%. On Monday, New York Fed President William Dudley made a strong case to raise rates. Dudley cited a soft US dollar and strong global growth as reasons why inflation would increase and also translate into stronger wage growth. Dudley said he expects inflation to reach the Fed's target of 2% in the "medium term", and predicted that the Fed would continue to gradually remove monetary accommodation. In last week's rate statement, the Fed announced that it would reduce its $4.2 trillion balance sheet by $50 billion/mth, starting in October.

Germany held a national election on Sunday, and the markets are following the results with caution. Angela Merkel's CDU won 33% of the vote in the German election, which means that Merkel will have to enter arduous negotiations with other parties in order to form a coalition government. The center-left SFD, which won 20% of the vote, has already said it will not join the CDU, so Merkel has her work cut out for her. The far-right AFD ran on a far-right, anti-immigrant platform, and the party's surge in support has sent shock waves in Germany and across Europe. The AFD cannot be considered as a coalition partner, which leaves the Greens and the pro-business FDP party as the most likely configuration. However, the FDP has insisted on the powerful finance portfolio and will likely try to reduce German transfer payments to the European Union. If negotiations become deadlocked, gold prices could rise in response to nervous markets.

Angela Merkel has secured her fourth term in office as her Conservatives (CDU/CSU) remained the largest party with 33.0%, followed by the Social Democrats (SPD) with 20.5%. However, both parties registered significant losses in their vote shares to the benefit of the euro-sceptic AfD party, which will become the first right-wing nationalist party to enter the Bundestag since the 1950s, with a vote share of 12.6% (see Chart 1). Although the AfD outperformed previous polls, its chances of realising any of its policy goals (Table 2) remain very slim, as all other parties have ruled out any cooperation with it. Together with the Greens and the Left, the Liberals (FDP) will also re-enter the Bundestag, taking the total number of parties in parliament from five in 2013 up to seven (Chart 2).

In line with similar trends observed in the Dutch and French elections this year, Election Day brought a dire defeat for the SPD, which recorded its worst ever parliamentary election result. The outcome now leaves only two viable coalition possibilities that can obtain a majority: another grand coalition of CDU/CSU and SPD or a 'Jamaica' coalition of CDU, FDP and the Greens (Table 1). However, as the SPD leadership currently rules out another grand coalition under Merkel because of its disappointing election result, a Jamaica coalition seems increasingly likely in our view. Note, however, coalition talks will be difficult and take several weeks or even months in light of the more fragmented political landscape, and the new government composition might not be known before November or December this year.

The election result means that we will probably enter a period of heightened political uncertainty in Germany over the coming weeks as coalition talks drag on. However, we expect that a solution on a government formation under Merkel as Chancellor will eventually be found before the end of the year. Hence, we believe that any adverse market reaction will be short-lived given the high degree of policy continuity under a CDUled coalition and the AfD's political isolation in parliament. The CDU plans to increase spending on infrastructure and lower taxes should strengthen domestic demand-driven growth in the future, in our view, and support the economic recovery in the eurozone and a gradual scaling back of ECB stimulus over coming years. However, difficult coalition talks ahead raise the bar for any swift progress on potential eurozone reforms as initiated by Emmanuel Macron, also in light of the FDP's more conservative stance on fiscal risk-sharing.

Full report in pdf