Following French presidential elections last year, the bullish case for the euro was largely driven by accelerating economic growth and falling political risks. While we’ve been bullish on the euro for quite some time, upcoming political events and slowing growth expectations are putting a dampener on the rally. This coming Sunday, the outcome from Italian elections as well as an SPD vote (in Germany) on another “grand coalition” deal with Angela Merkel’s CDU/CSU will be announced. Looking at Italy, the Eurosceptic “Five Star Movement” (Movimento 5 Stelle) is currently leading the polls. Turning to German politics, polls indicate that only a slim majority of SPD delegates view another coalition deal in a positive light. Finally, forward-looking economic indicators (such as Eurozone manufacturing PMIs and the German IFO expectations) have deteriorated this year. With politics and economic growth weighing on the future outlook, going long euros is less compelling today.

Italian elections a meaningful risk

The biggest threat to the status quo is the possible victory of M5S, a Eurosceptic party pushing for a greater degree of direct democracy and limits on immigration. Looking at M5S’s agenda, leader Beppe Grillo had previously called for a national referendum on Italy leaving the euro area, but has since moved away from this position. While the party is currently leading in the polls (27% – 29.4%), it is unlikely to form a majority government without coalition partners. The center-right coalition is currently polling between 34.7% and 38.6%, while the center-left coalition is polling between 26% and 29.3% according to Reuters Italy. Given recent constitutional reforms, no party is likely to form a majority without forming a coalition based on latest polling figures. The election results on May 4 are thus unlikely to be conclusive. As a result, many investors are confident that Italian elections pose a limited threat to the unity of the Eurozone.