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Trader’s Guide to the Euro Before French Presidential Elections

Trader’s Guide to the Euro Before French Presidential Elections

The second round of French Presidential elections on Sunday is the biggest scheduled risk event for the euro in the days ahead and a key driver for its direction in the medium term.

The base-case scenario is for President Emmanuel Macron to win, even by a narrow margin. This is considered a euro-friendly outcome that should keep it off cycle lows. If his anti-establishment and nationalist rival Marine Le Pen prevails, the common currency should meet a fresh round of selling, with bearish bets intensifying amid concerns she could also clinch legislative elections in June.

The euro fell to the lowest level in two years against the dollar this month, and is coming under pressure as the European Central Bank is expected to tighten monetary policy at a slower pace than the Federal Reserve. While Le Pen has scrapped an explicit pledge to pull France out of the European Union, her broad anti-immigrant and free-trade platform remains, which would further cloud the outlook if she emerges victorious.

For now, the latest polling average calculated by Bloomberg shows Macron leads by 55.5% to 44.5% ahead of the April 24 vote. Moreover, the gap between the two candidates has widened by 1.8 percentage points during the April 15-19 period, and suggests Macron maintains a solid momentum ahead of a crucial debate later Wednesday.

Here’s what charts and options gauges suggest is in store for the euro in each scenario.

Technicals

A Macron win should spur a knee-jerk reaction higher, at least on a relief-rally basis. The first key resistance for the euro would be its 21-daily moving average, currently at $1.0928. A daily close above $1.0954, the April 11 high, would open further topside potential.

Trader’s Guide to the Euro Before French Presidential Elections

The euro traded 0.3% stronger at $1.0813 as of 9:14 a.m. in London. 

A Le Pen victory would probably see the currency gap down to $1.0727 at the Monday open in Asia, the April 2020 low. Bears will target the key support area at $1.0636-$-1.0638, levels last seen during the pandemic-induced mayhem in March 2020. 

A further deterioration in sentiment would mean important technical supports and barriers around $1.05 could eventually come to the test. 

Trader’s Guide to the Euro Before French Presidential Elections

Options

The euro’s volatility skew and term structure clearly embeds French political risks. The skew, which depicts the difference between topside and downside hedging costs across tenors, shows bearish sentiment is the highest on the one-week tenor and eases thereafter. 

The term structure, or the curve that depicts the various implied volatilities of options with the same strike and different maturities, shows hedging costs are the highest in the short-term, in what is called a curve inversion. 

Trader’s Guide to the Euro Before French Presidential Elections

A Macron win should see term structure inversion fading, with volatilities that capture the next meetings by the Fed and the ECB impacted the most.

The skew is expected to flatten, which could mean that unwinds of exiting euro-negative exposure could spill over into the spot market. Options expiries over the next month show the market is underinvested on a move below $1.07, and especially below $1.05. Meanwhile, there is room to add bullish wagers above $1.09 and $1.10.

Positioning

Data from the Depository Trust & Clearing Corp. show that euro options trades are rather balanced so far this week, with 56% of the total notional having gone through in favor of a weaker euro. 

Hedge funds and institutional investors have already hedged a Le Pen win through options when costs were significantly lower, according to traders in London and Frankfurt familiar with the transactions, who asked not to be identified because they aren’t authorized to speak publicly.

When it comes to the spot market, investors are short the euro heading into the vote, the traders say, as leveraged desks are looking for better levels to short the common currency.

  • NOTE: Vassilis Karamanis is an FX and rates strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice

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