Citi has highlighted the potential for increased political risks in Europe as German regional elections are set to commence on September 1. According to Citi European Economics, the elections could lead to significant shifts in regional policies, potentially destabilizing the national coalition, altering national fiscal policies, and causing a reorientation of Germany's policies within the EU and on an international level.
The financial markets have shown a heightened sensitivity to election-related risks this year. Similar events, such as the recent French elections, have previously influenced the euro, leading to a decrease in the value of EURUSD and EURCHF, in line with spread widening.
These developments suggest that the upcoming German elections could also provoke market volatility, particularly affecting foreign exchange rates.
Citi's analysis indicates that the uncertainty surrounding the election outcomes may coincide with a seasonally stronger US dollar and an increase in volatility leading up to the US election.
The firm notes that the DXY, an index measuring the dollar's strength against a basket of currencies, continues to find support, while there is already a trend of leveraged positions being short on the US dollar and long on the euro.
In light of these factors, Citi maintains a cautious stance on the euro, adopting defensive positions against potential downside risks. The firm remains positioned short on the euro through a two-month EURUSD put option with a strike price of 1.08 (reference spot price at 1.1121 as of 9:16 am EST, August 28) and holds a short position on EUR/GBP in the spot market (reference spot price at 0.8413 as of 9:16am EST, August 28).
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