Macron / Bayrou Hook-up Triggers Euro U-Turn but Risks Still Point to Lower Exchange Rates

Above: Emmanuel Macron, © Pound Sterling Live.

Having suffered a poor start to the week against the Pound Sterling, US Dollar and other global currencies we have since witnessed a stabilising in the Euro on the latest shift in the volatile race for the French presidency.

The shared currency saw a shift in fortunes on Wednesday, February 23 when it was announced Francois Bayrou had decided to pledge support to Emmanuel Macron.

This is significant as we noted previously here that centre-right politician Francois Bayrou was sounding as though he may well stand and further muddy the waters.

Bayrou would not be expected to make the second round, but he would take some support from Fillon and potentially Macron as well.

“EUR/USD got a lift from Francois Bayrou's decision to ally himself with Emmanuel Macron rather than stand in the French presidential contest himself. That's lifted the Oddschecker odds of a Macron victory back up to 39% this morning, reversing a three-week downtrend,” says Kit Juckes, a foreign exchange analyst with Societe Generale.

The news narrowed the OAT/Bund spread by about 5bp which has helped the broader Euro exchange rate complex.

Nevertheless, Juckes is not convinced this Macron blip will be enough to aid the Euro and he sees further potential weakness:

“There will be further twists and turns in the election race and EUR/USD remains a short-term sell even if the longer-term outlook is heavily skewed the other way.”

The EUR/GBP exchange rate recovered to 0.8492 on the news but continues to look heavy as we believe investors will continue to remain shy of the Euro until a clear pro-European outcome to the French elections becomes apparent.

Macron has Better Chances than Le Pen

Polls have both Macron and Fillon besting Le Pen in the second-round of the Presidential vote, however we have seen Le Pen close the gap of late.

"Government bond markets reacted with relief to the announcement of the candidate for the French presidency Francois Bayrou to withdraw his candidacy and to support Macron. Macron would have a better chance of winning against Le Pen than conservative Fillon in the second round of voting, who however is more or less on par with Macron in current surveys," says Christoph Klaper at Raiffeisen Bank International in Vienna.

Bayron’s decision made yesterday has thus diminished the likelihood of Le Pens’s election victory seen by the markets.

The 10-year French government benchmark yield fell by more than 7bps during yesterday’s trading session, thereby tightening more than 5bps to the 10Y German government benchmark yield which aided the broader Euro complex higher.

The first round of voting will be on April 23rd with the final vote set for May 7th.

Euro to Fall to Parity Against the Dollar

The Euro fleetingly broke below $1.05 on Wednesday for the first time since early January.

Against the Pound it broke below £0.8450 for the first time since December.

And more losses are likely, particularly against the Dollar we are told.

“We still expect the exchange rate against the dollar to fall through parity this year, as the contrast in the policies of the ECB and the Fed proves to be starker than investors are anticipating,” says John Higgins at Capital Economics in London.

Higgins takes a step back from looking at the now well-publicised economic risks that are being written into the Euro and argues the driver for a fall to parity lies in the United States.

“We still think that investors are underestimating future Fed rate hikes. And since we broadly agree with them that monetary policy in the euro-zone is likely to remain very loose for the foreseeable future, this suggests to us that the dollar has even further to rise against the euro – our end-year forecast is $0.95/€,” says Higgins.

On Wednesday, February 22 the US Federal Reserve’s minutes for their February meeting communicated a reluctance to push for a March hike owing to ongoing uncertainty surrounding the new administration’s fiscal policies.

Once these are made clear we will get a better steer as to whether the Euro will plunge to fresh multi-year lows.