FX: More headaches for the SNB?
The stubborn low volatility in EUR/USD recently has been a function of the euro’s reduced sensitivity to political dynamics in Italy. Politics proved to be a major drag on the common currency in 2018, when a stormy budget season spurred market risk aversion in the eurozone. Since then, the euro has become less sensitive to both market data and the political backdrop; the fall of Italy’s previous government in August left no mark on EUR/USD.
In line with this, we expect the impact on EUR/USD to be broadly limited, and may only become evident (on the downside) in the event that an early election is called and the market prices in more significant political risk. Even in such scenario, we think it is unlikely that EUR/USD will fall below 1.09 and cannot exclude an even less pronounced downward move.
We expect most of the FX impact of the regional election to be channelled through the Swiss franc. EUR/CHF has faced renewed pressure this week – after losing 75 basis points in the previous week – on the back of the ECB rate announcement. The prevailing question in the market remains, at what point will the Swiss National Bank allow the franc to appreciate before it intervenes?
For now, our suspicion is that markets will keep trying to test the SNB’s patience, and Italian political risk is indeed a potential catalyst considering the high sensitivity of EUR/CHF to this specific risk factor. Accordingly, a victory by the centre-right candidate may well prompt another leg lower in EUR/CHF. If, as we expect, the government confirms it will stay in power, some of those losses should be reversed within a few days of the vote. In the worst case scenario for risk (snap election) the pair may instead fall more sharply, possibly to the 1.05 area. However, a win by the centre-left should help to price out some of the short-term uncertainty and allow EUR/CHF to head towards 1.08.
In the longer-term, political risk in Italy appears to be a ticking bomb for EUR/CHF and even if we expect the current government to survive through 2020, the risk of a sudden break-up in the coalition remains quite material, as the past few years have taught us.