Optimism over the recent euro rally is fading.
Speculative investors have cut their exposure to the shared currency to the lowest level this year, as caution ahead of the Italian election and German coalition vote on Sunday sets in.
According to data from the U.S. Commodity Futures Trading Commission out late Friday, hedge funds and money managers slashed their net long positions in the euro EURUSD, +0.0406% to 126,126 contracts in the week ending Feb. 20. That’s the lowest level since late December.
The dwindling of enthusiasm comes after a bullish period for the euro, which hit a more-than three-year high against the dollar at $1.25 earlier in February. That rally came on expectations the European Central Bank soon will start to tighten its monetary policy.
However, after some disappointing economic data last week and on unease ahead of the two key political events in Germany and Italy, euro traders are turning somewhat wary, analysts noted.
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“The story for the euro this week is one of caution as markets shift their focus to the political equivalent of ‘Super Sunday’ this weekend,” said Viraj Patel, FX strategist at ING, in a note.
On March 4, Italy goes to the polls in a national election whose outcome could potentially rattle the eurozone and shake up financial markets. On the same day, Germany’s center-left Social Democratic Party announces the result of its vote on whether to join a grand governing coalition with Chancellor Angela Merkel and her center-right Christian Democratic Union.
“We think the market may be underestimating the risks here — especially given that the EUR’s pro-cyclical and portfolio inflow-driven rally could run out of steam if political risks stay slightly elevated in the near-term,” Patel said.
“We see politically-induced downside risks for EUR/USD this week towards 1.2100/30,” he added.
The euro on Tuesday traded at $1.2341, up from $1.2319 late Monday in New York.
Polls currently suggest that the SPD in Germany will endorse a coalition with Merkel, which would end five-months of political uncertainty in Europe’s largest economy. Germany held a general election back in September that crowned Merkel as the winner, but the victory came with historic low support and not enough votes to form a government alone.
However, should the German coalition proposal fall apart on Sunday, the euro is in for a selloff, according to currency strategists at BBH.
“It would force either a minority government or new elections. New elections are risky,” they said. “If new elections are needed, it is less clear that Merkel will survive as Chancellor, and it raises questions about new initiatives in Europe this year.”
In Italy, polls point to no cleat outcome, which is also feared could lead to new elections and extend the period of political uncertainty in Europe.