Bearish bets against the euro tied to the risk of Marine Le Pen winning the French presidency have faded on the consistently strong polling of independent centrist Emmanuel Macron, but concern that he may not be able to count on support in parliament is likely to keep volatility relatively high for months ahead.
The cost of hedging against a fall in the value of the euro fell markedly in March, according to data compiled by Alvin Tan, a director in foreign exchange strategy at Société Générale.
The six-month euro-dollar risk reversal — where a rise indicates the price of bets on a stronger euro is rising relative to bets against it — has surged from a low of -2.255 on February 22 to -1.0925 on April 6.
Both the euro-dollar and euro-sterling risk reversals had fallen dramatically in late January and early February, coinciding with a widening of the spread between French and German 10-year government bond yields. This was "likely as a result of higher perceived French political risks," said Tan.
The spread between 10-year French OATS and bunds has in the last few months moved virtually in tandem with the poll numbers of far-right candidate Le Pen, who investors see as a big risk to the French and European economies as she wants to take the country out of the European Union and the euro.
Falling demand for bets against the single currency indicates investors are becoming more confident of a win for Emmanuel Macron, the centrist independent candidate. While polls indicate he and Le Pen will face each other in a run-off vote May 7 after an April 23 first round, he is seen winning with roughly 60% of the vote.
However, while investors may be feeling more confident that Macron will prevail, his lack of a party structure means his chances of being able to rely on support in the next parliament are unclear. This uncertainty is continuing to add tension to the markets, helping to keep the OAT-bund spread at 65 basis points, up from 21 basis points as recently as Aug. 10, investors say.
"This is an important point market participants need to consider," said David Zahn, head of European fixed income at Franklin Templeton Investments, who does not believe either Macron or Le Pen would have an easy time winning support in the National Assembly, which will be elected in two rounds of voting on June 11 and 18.
"Macron is from a new political party and therefore has no seats in the National Assembly," he said.
"Le Pen only has two. In the context of 500-plus seats, both will have some work to do. If either win, we think all eyes will shoot forward to the parliamentary elections in June, so we will likely see continued volatility for the next few months."
Concerns for Le Pen ...
The National Assembly is France's lower house, but has a bigger role than the upper-house Senate in passing ordinary legislation such as budget bills, meaning a majority in the National Assembly is typically enough for a government to enact law changes.
The Senate — where 170 of the 348 seats are up for grabs in September elections — is critical to making a change to the constitution, which Le Pen would need to remove France from the EU.
Under the constitution's Article 89, such a change would be possible with support from 60% of the combined National Assembly and Senate. Alternatively it could be passed via referendum, which is Le Pen's preferred option, but holding that referendum would still require a simple majority in both houses.
"Given that Le Pen is very unlikely to enjoy a majority in the National Assembly and even less likely to do so in the Senate, it is safe to assume that Le Pen will be unable to apply Article 89," said Société Générale's economists in a note published March 14.
And for Macron
While investors see far more risk to markets from a Le Pen presidency than a Macron one, there is still skepticism over the effectiveness of the latter's economic policies and his ability to enact them.
Macron served as economy minister in François Hollande's Socialist government, but quit in August 2016 to launch an independent presidential bid under his new En Marche! party.
Zahn at Franklin Templeton expects a Macron victory on May 7 will lead to a rally in French government bonds, "at least in the short term."
However, longer term, he thinks French bonds would weaken under Macron, "because at present his policies are unclear and seem set to do little to address two major economic concerns: France's high debt-to-gross domestic product ratio and high current account deficit."