Euro Slumps as European Politics Raises Market Uncertainty

Naomi Tajitsu and Vassilis Karamanis
·3-min read

(Bloomberg) -- Heightened political uncertainty in Europe is piling pressure on the euro.

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The common currency slid to its lowest in a month against the dollar after French President Emmanuel Macron and German Chancellor Olaf Scholz were trounced by far right parties in European elections Sunday. With the results leading the former to call a snap legislative ballot at home beginning on June 30, options markets show traders expect bigger swings and further losses.

The concern is that the outcome of the elections has also darkened the longer-term outlook for the world’s second-most traded currency, as it throws into question the prospects for greater integration and a united Europe. It’s making trading more volatile after markets have been subdued for the past year.

“If there is something that we learned in the peripheral crisis is that the euro does not like political instability,” said Roberto Cobo Garcia, head of G-10 FX strategy at Banco Bilbao Vizcaya Argentaria SA in Madrid. “Volatility was surprisingly low at the beginning of June but it should rise given the uncertain political and geopolitical scenarios.”

A gauge of volatility in the euro over the next month surged to the highest since mid-May. Pricing in the options market shows traders have turned bearish on the common currency at the fastest pace in over a year, leaving sentiment the most negative since April.

The euro fell 0.6% to $1.0738 after Macron announced the election, which will take place over two rounds in a battle with far-right rival Marine Le Pen. The vote may open the door to more influence by her National Rally party and undermine Macron’s ability to push through legislation. French bonds slid to take benchmark borrowing costs to the highest this year.

“The prospect of a French election with a highly opaque outcome gives no reason to buy the euro,” said Peter Kinsella, global head of FX strategy at Union Bancaire Privee Ubp SA. “We can expect euro underperformance for the next three weeks.”

Strategists are focused on the potential impact to France’s economic outlook in particular, with the country’s banking stocks sliding Monday. Investors may also start questioning European resolve toward closer fiscal and financial integration, according to Credit Agricole’s Valentin Marinov.

“This could be seen as a blow to the nascent euro-positive sentiment that has started to dominate the FX markets in recent weeks,” said the French bank’s head of G-10 FX research and strategy. “Any renewed widening of peripheral sovereign yield spreads to bunds could be seen as negative for the euro.”

Bullish Bets

The move comes just after leveraged funds flipped to a net bullish position on the euro for the first time since August, according to the latest data from the Commodity Futures Trading Commission. The currency had strengthened about 3% from an April low in advance of the European Central Bank’s widely telegraphed interest-rate cut last week, as traders chose to focus on where policy might head next with inflation still high.

But now traders will also have to factor in political uncertainty to their wagers.

The common currency could fall to $1.05 in the third quarter, said Alvin Tan, strategist at RBC Capital Markets in Singapore. “Political risks are rising for the euro again.”

--With assistance from David Finnerty, Masaki Kondo, Ruth Carson and Matthew Burgess.

(Update prices, adds options details and analyst comment.)

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