EUR/USD: Weighing the risks – Rabobank

Jane Foley, Senior FX Strategist at Rabobank, suggests that the French political risk appeared to take a step back over the weekend as independent Presidential candidate won a third endorsement in less than a week and as opinion polls showed his support just a small margin behind that of the far-right’s Le Pen in the first round of the election. 

Key Quotes

“Opinion polls have consistently indicated that Le Pen is on course to be beaten in the second round of the race.  However, scepticism about the inaccuracies of some polls into last year’s UK EU membership referendum and the US election has led to some investors taking out some insurance against a Le Pen victory.” 

“It is undeniable that uncertainty ahead of the French election has placed some downward pressure on the EUR in recent weeks.  However, the EUR is a long way from being a perfect gauge of perceived political risk for any single country within the Eurozone.  Although concerns about the French election, in particular Le Pen’s support from Frexit, have caused some EUR selling, the fact that Bunds are perceived to be a safe haven asset has ensured that much of the movement from the French government bond market this year has required no currency redomination.”

“Germany has a huge current account surplus at 8.6% of GDP and this will afford the EUR significant protection to negative political news from within the Eurozone’s borders.  In other words, the EUR is not as vulnerable to political risk as a currency such as GBP which is exposed to the UK’s current account deficit.  That said, the EUR has been on the back foot against the safe haven JPY and CHF since the end of January and we would expect the CHF and the JPY to hold their better tone vs the EUR ahead of the spring French election.”

“The ability of Trump to re-ignite reflationary fears today could set the tone for the markets in the coming weeks.  In particular, it could have sway over the market’s expectations of Fed tightening this year.  Expectations of stronger US growth and higher Fed interest rates would help promote the USD across the board and re-focus attention on the carry trade that was responsible for the surge in the value of the dollar index into the end of last year.”

“However, we expect that continued scepticism and the likelihood of delays over fiscal expansion to temper USD potential.  Overall, while we see scope for EUR/USD to edge towards 1.05 ahead of the French elections, we see disappointment over reflation in the US to lift the currency pair towards 1.10 by the end of the year.  This forecast assumes that Le Pen does not win the French Presidency.”