Article / 18 April 2017 at 13:33 GMT

Macro Digest: Euro emerges as French election surprise — #SaxoStrats

Chief Economist & CIO / Saxo Bank
Denmark
  • EUR strength the big surprise of the French election campaign so far
  • French/German bond spreads widening ahead of April 23
  • Fillon could surprise by making it through to second round
  • French constitution means new president's room for manoeuvre will be limited
  • Read more on our dedicated Europe Divided page

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A big turnout could see French voters desert the
cafes for the booths Sunday. Photo: Shutterstock

By Steen Jakobsen

What is the real surprise so far of the French election?

The French election has seen several major surprises, but the biggest surprise market wise has been how well the euro has been able to trade despite serious headwinds from Brexit and the rise of anti-Euro candidates.

This “chaos” has been seen in FX risk reversals and bond spreads but not really in euro.

EURUSD 25 delta risk reversal (Put bid over Calls)
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 Source: Bloomberg

Euro Puts cost 400 basis points more than the equivalent EUR Calls…..and from a “near certain Emmanuel Macron victory in early March, the market now fears a second round of far-left vs. far-right, that is Jean-Luc Melenchon vs. Marine Le Pen. This is still unlikely in my opinion but the real surprise at this stage would be Francois Fillon vs. Le Pen or Fillon vs. Macron.

Meanwhile the German/France bond spread has continued to expand.

Two-year French/German government bond spread
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 Source: Bloomberg

In a “normal market” these elevated risk levels would have meant a EURUSD rate trading somewhere between 1.00/1.03 instead of 1.0690 at the time of writing.

The outperformance or “premium” is partly explained by Europe's growth velocity which continues to expand….

Bank of Italy, Ecocoin Growth Indicator
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Source: Bloomberg

Partly it is also that European equities still trade at a big discount especially to the US market, which has fed a continued stream of overweight recommendations…

Add this to the “real economic fundamentals” of a large current account deficit (3.35% of GDP) and a “discount” in inflation (Euro: +0.7% vs. US +1.7%) which will enable the low inflation currency to outperform high inflation over time due to changes in purchasing power.

Euro current account surplus (% of GDP)
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 Source: Bloomberg

Non-European are extremely nervous about the French election, partly from the bad experience of Brexit and the US election, but also because they fear Le Pen and now Melenchon will pursue an agenda of Frexit. There are so many flaws in that theory, but first let’s look at the book makers prices for the election (and yes, they were wrong twice before).

Odds for President of France 
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 Source: Oddschecker, Bloomberg

What’s really interesting in this “betting based” President poll is that Le Pen now has less chance than Fillon of becoming President.

Maybe the real surprise is a Macron vs. Fillon second round?

Back to the “concern” about the euro being targeted by Le Pen or Melenchon – here I want to repeat the procedure in France and the famous article 89 in the French Constitution .

“The President of the Republic, on the recommendation of the Prime Minister, and Members of Parliament alike shall have the right to initiate amendments to the Constitution. 

A Government or a Private Member's Bill to amend the Constitution must be considered within the time limits set down in the third paragraph of article 42 and be passed by the two Houses in identical terms. The amendment shall take effect after approval by referendum.

However, a Government Bill to amend the Constitution shall not be submitted to referendum where the President of the Republic decides to submit it to Parliament convened in Congress; the Government Bill to amend the Constitution shall then be approved only if it is passed by a three-fifths majority of the votes cast. The Bureau of the Congress shall be that of the National Assembly.

No amendment procedure shall be commenced or continued where the integrity of national territory is placed in jeopardy.

The republican form of government shall not be the object of any amendment”

The Prime Minister, the government or a 3/5 majority is needed even to table an amendment to the Constitution, so yes both Le Pen and Melenchon can become president but the Constitution stops them from being able to execute, as the Parliamentary election in June will not give them the political power to rule – a vacuum could develop and that’s the most likely risk independently of whether it’s Le Pen, Macron, Melenchon or Fillon who is France’s next president .

The French election will in that way be no different to Donald Trump’s victory in the US. Yes, “they” may grab the power, but the ability to change the political process is very different from winning a lottery of an election – Just ask president Trump.

We still believe in Macron as president, but we are defensive enough to recognise this election will be close, maybe too close for comfort as the populous movement has a lot of ammunition due to the inequality and the poor performance of the economy. 

Their solution, however, is a romantic, if not naive, version of the 1950s and 1960s when the world was less complicated, had less trade and less technology.

Today’s world needs visions and all the elections including now the UK one, have little to offer. If anything, this political cycle may have another two years of running before voters again seek a future defined by more competition, more basic research, open trades and innovation, the very definition of productivity which is the only long-term solution that is neither political or unequal.

I see the EURUSD trading above 1.1000/1.1200 post the June Parliamentary election in France, a Le Pen/Melenchon election could mean a test of parity, but the above fundamentals will drive EURUSD back to 1.0500 quite quickly.

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 Macron remains the favourite, but he's no certainty. Photo: Shutterstock

— Edited by Martin O'Rourke

Steen Jakobsen is Saxo Bank's CIO and chief economist
18 April
helicongrowth helicongrowth
Great piece and EURUSD is cheap/ will be higher on a non Le Pen, Melenchon win. The USD is weakening but who wants to run long Euros into French election ? EURUSD call spreads the way fwd maybe ?
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