Euro-Dollar Holding 1.0% French Risk Premium

Image © European Central Bank

Researchers at MUFG Bank say the Euro has a risk premium of about 1.0% due to uncertainties over the French election.

This would suggest political uncertainty has left the single currency undervalued relative to its typical drivers, particularly the economic data flow.

Although fears over the ascendency of the RN party in France's legislature have eased somewhat this week, the issue is still seen to be restraining the Euro.

"The elevated political risks in Europe is certainly holding the euro back and EUR/USD would likely have rebounded more notably yesterday after the weaker than expected retail sales data in the US," says Derek Halpenny, Head of Research for Global Markets at MUFG Bank Ltd.

The Euro to Dollar exchange rate hit a low of 1.0667 last week as markets digested the implications of President Emmanuel Macron's decision to call a snap legislative election. The pair has recovered off the floor and rallied in the wake of U.S. retail sales data on Tuesday, but gains were limited to 1.0740.

"The euro has stabilised helped by evidence that investor fears over the rise of RN in France have eased somewhat. Based on price action since the snap election by President Macron we estimate via swap spread moves an approximate 1% risk premium is currently in the price of the euro," says Halpenny.

This risk premium could limit the Euro's rebound potential against the Dollar in the coming days, and most analysts we follow look for the exchange rate to be contained within the 1.07s short-term. Stability has returned to the market on a belief the RN will be constrained given the expected hung parliament outcome, which markets currently see as being the most likely outcome of the vote.

Halpenny says there are, nevertheless, some risks. 

"If there is any sense of that view changing in the coming days or if RN do better than expected in the 1st round on 30th June, we would still expect the political risk premium to increase and EUR/USD would likely trade below the 1.0500 level going into the second round on 7th July," he says.