Euro Uncertainty And Existential Threats

The EUR has faced a couple of huge risk events. The Brexit decision by the U.K. in June and the Presidential election of Donald Trump early November caused a whirlwind of trading for the Single Currency. However, up until now the EUR has been spared a direct confrontation with political uncertainty.

All of that could change with the Italian Constitutional Referendum, which will take place this Sunday. If polls in Italy and recent outcomes from the U.K. and U.S. are correct indicators, it is likely Italian citizens will reject the constitutional reforms being asked for from the current Italian government led by Prime Minister Matteo Renzi.

If the outcome of the vote is no, it may trigger a no confidence vote it Italy. Which means Italy could have a change of government in the mid-term, one that is not going to view a partnership with the European Union and mandates from the ECB as their first priority.

Populist sentiments have gained momentum globally and Europe is certainly not immune to the potential effects from voter rebellions. Manufacturing PMI numbers presented from Germany and France today essentially met expectations, but economic growth remains a real challenge for Europe.

The ECB will be meeting next week and a No vote from the Italian Constitution Referendum will not be welcome news. In an address in front of the European Parliament last week, ECB President Draghi outlined concerns about continued lackluster growth from Europe, but he highlighted political uncertainty.

While Draghi didn’t specify Italy by name, there can be no doubt that the European Central Bank is not comfortable with the notion of an Italian rebellion in its fiscal midst. Add the election in France for President in April of 2017 and a likely victory for conservative Francois Fillion as President or at the very least a strong ‘right’ leaning government and the equation becomes even tougher. The notion of regulations from the European Union which are seen as heavy handed by some, and the political rebellions that are brewing in Italy and France have the makings of a dynamic cake that will do the EUR no favors.

The EUR has gained the last few days and is maintaining short term strength near resistance, but the Single Currency may begin to face questions as investors ponder their positions going into the weekend with the Italian Constitutional Referendum on the schedule for Sunday. The possibility of having to return to their offices on Monday, confronting a risk event which is firing salvos directly at the EUR instead of from afar could be awaiting investors.

The EUR has handled the crisis of the Brexit relatively calm and has maintained its core value rather well compared to the GBP. A cheaper EUR could be welcomed by European exporters, but the ego of the European Central Bank and thoughts of citizens in Germany and other E.U. nations will not be one of contentment.

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The EUR could endure a firestorm of volatility if the Italian vote’s outcome is negative. In the short term EUR investors may try to shrug off a bad result in Italy, but long term it may be the beginning of a very tough road for the Single Currency in which it must deal with an existential threat.

Written By: Robert Petrucci