Let’s face it: the French elections are going to dominate the market news cycle for the foreseeable future.
There’s quite literally no outcome that won’t pose some manner of threat.
Indeed, as we pointed out earlier this week, every market pundit’s “optimal” scenario (Macron vs. Fillon in the second round) could end up being the long-term worst-case scenario, as it would increase the chances of what one French official described to Politico as “five more years of paralysis, high unemployment and next-to-no growth,” which would in turn make “the country ripe for the National Front” in the future.
So you know, France is probably damned if they do and damned if they don’t.
Unsurprisingly, analysts have focused first and foremost on the likely FX impact of the various possible second round combinations. This makes sense because, as we’ve been pounding the table on for months, today’s macro environment is one in which FX is the transmission mechanism through which geopolitical developments influence other asset classes (to be sure this has always been the case, but we’ve argued the dynamic has been magnified over the past year).
We discussed one potential land mine on Saturday in this week’s most popular post, the colorful and expertly crafted “‘You’re Gonna Frighten People’ – Bill Murray Does Frexit.” Specifically, we cited BofAML who recently noted that while the demand for hedges is perceptible, the very fact that they are hedges in the first place means a lot of people are long EUR and € assets.
Here with more on the FX implications of Sunday’s electoral trial by fire is Barclays…
Overview: French elections – too close to call. The highly uncertain first round of the French presidential elections has the potential to create two very different market environments this week. A “disruptive” result, which increases the risk of a radical President being elected (Fillon vs. Le Pen, Fillon vs. Melenchon, or the most potentially disruptive, Melenchon vs. Le Pen) would likely weigh heavily on the EUR, particularly against the JPY. EM FX and risk assets should also perform poorly in this environment. In contrast, a “benign” result that implies a high probability of a mainstream candidate becoming president (Macron vs. Le Pen or Macron vs Fillon, for example) should be broadly supportive to the EUR, EM and risk assets.
The French election also may have bearing on some central bank meetings this week, including the ECB, BoJ and Riksbank in G10 (all Thursday) and NBH (Tuesday), CBT (Wednesday) and CBR (Friday) in EM. We expect all to leave policy settings unchanged, except the CBR, which is likely to cut 25bp, in line with consensus. Following a “disruptive” election outcome, however, the market may expect a more accommodative tone from the ECB, and the Riksbank is likely to announce an extension of its QE programme that is due to end in June. Following a “benign” outcome, markets may look for indications from both central banks as to the timing of policy normalisation in the context of a more certain political backdrop. In this environment, we think the Riksbank will announce the end of QE programme, effective from July, likely supporting SEK.
A “disruptive” French election outcome may delay the GBP’s appreciation to fair value from a point of undervaluation as market participants worry about the implications for Brexit negotiations. A “benign” election outcome should support continued GBP appreciation, as the upcoming 8 June UK election is increasingly viewed as reducing UK political uncertainty. As we argue, an expansion in the current information set available to market participants should reduce currency risk premia. We currently estimate GBP is about 9% below its long-term fair value on a real effective exchange rate basis. We continue to forecast most of this discount to be removed by year end but the early UK election may see it happen faster than our current forecasts imply. Also this week, the US Congress will need to approve a spending bill to prevent a shutdown of the federal government, which may delay a possible second health care bill being passed before the 100th day of the Trump administration (29 April). In addition, Trump announced that the tax reform plan will be unveiled on Wednesday, adding to the heavy legislative agenda.
EUR: French elections to dominate sentiment For discussion of the EUR and Thursday’s ECB meeting in the context of the first round of the French presidential elections.
GBP: On an appreciation path; French elections a near-term risk. Sterling’s recent rally has supported a total gain of about 6% in our long GBPAUD trade since we initiated on 23 March and given impending French election risk we are tightening the stop to our entry level of 1.60 from 1.55 previously and continuing to target 1.75.
As noted in the overview section, the positive GBP reaction to last week’s announcement of an 8 June snap election is appropriate, in our view (Figure 7). In most scenarios the election should improve the government’s negotiating position and reduce political uncertainty, creating risks of a faster GBP reversion to fair value than our forecasts imply. Despite last week’s appreciation, GBP remains about 9% cheap on a real effective exchange rate basis (Figure 8). An outcome consistent with current polls should increase the Conservative government’s majority materially, providing Prime Minister May with greater ability to oppose hard-line Brexiters within her party and pursue a more moderate stance. Her possible direct election is also likely to reinforce the government’s negotiating position and would probably occur even in the event of an unchanged Conservative majority. The risk of the election delivering a stronger opposition is not necessarily negative for GBP if its unifying theme is pursuing a softer Brexit.
The key data point this week is Q1 preliminary GDP (Friday). We and consensus expect a 0.4% q/q increase, which implies 2.1% y/y. We anticipate weakness will be most pronounced in the services sector.