Why the Fed’s plans could cause a ‘turning point’ for the currency market

Germans are set to vote this Sunday in the country's parliamentary election, which will ultimately decide whether Chancellor Angela Merkel will hold her position for another four years.

It is widely expected that Merkel will capture the victory. While some strategists say the election is unlikely to cause a market stir, the euro could nonetheless see upcoming volatility on the Federal Reserve's plan to raise interest rates.

"The German election does not appear to be a market factor. There seems to be little doubt that Merkel will be reelected Chancellor and that Schaeuble will likely retain the Finance Ministry," Brown Brothers Harriman currency strategists wrote in a note to clients Friday morning, referring to Wolfgang Schaeuble, Germany's minister of finance.

The euro fell this week against the U.S. dollar, dipping in response to the Fed's intended interest rate hikes ahead, before paring some of its losses into the week's end. The central bank's remarks were essentially supportive of the dollar's strength, which in turn put pressure on the euro's value.

The euro has strengthened significantly this year as Europe has posted an economic recovery, said Gina Sanchez, CEO of Chantico Global. But looking ahead, the Fed's plans could derail its strong performance.

"The recent announcement by Janet Yellen that [balance sheet reduction] will begin in October has put a slight hitch in [the euro's trend] as the front end of the U.S. curve posted a taper tantrum and sent the dollar rallying. We think this could be a turning point for the euro," Sanchez wrote to CNBC in an email on Friday.

Sanchez pointed out that the German election is coming at a juncture when economic data has proved quite positive and said she believes (in line with the consensus view) that Merkel will win the election.

"Economically, the region is experiencing a very promising outlook with PMI and other macro data coming in stronger than expected and analysts continuing to revise projections higher," Sanchez wrote.

Furthermore, the euro could see heightened volatility as the European Central Bank and its head, Mario Draghi, move to normalize its monetary policy after holding its benchmark rates down at historically low levels.

Merkel's path to victory is "so secure that many have looked beyond the election to her next government," wrote Kathy Lien of BK Asset Management in a note to clients on Friday. A victory for Merkel, Lien wrote, "will mean a victory for the euro."

Lien added: "Although EUR/USD backed off 1.20 on Friday, investors are anticipating a win. In the very unlikely scenario that she loses, EUR/USD will crash quickly and aggressively and could fall below 1.18."


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Michael Santoli

Michael Santoli joined CNBC in October 2015 as a Senior Markets Commentator, based at the network's Global Headquarters in Englewood Cliffs, N.J.  Santoli brings his extensive markets expertise to CNBC's Business Day programming, with a regular appearance on CNBC's “Closing Bell (M-F, 3PM-5PM ET).   In addition, he contributes to CNBCand CNBC PRO, writing regular articles and creating original digital videos.

Previously, Santoli was a Senior Columnist at Yahoo Finance, where he wrote analysis and commentary on the stock market, corporate news and the economy. He also appeared on Yahoo Finance video programs, where he offered insights on the most important business stories of the day, and was a regular contributor to CNBC and other networks.

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