Monex Europe: Macron’s victory removes some tail risk, but political risks remain until June

25 april 2022

Emmanuel Macron’s victory in the second round of the French elections on Sunday was largely expected as preliminary polls suggested a 90% chance of a win.

This meant that the euro failed to hold onto its already mild gains overnight and instead fell to fresh lows last seen in March 2020, as broader USD strength dominated market price action in Monday’s open.

The result of the election still removes a tail risk for financial markets, which is shown by French spreads having narrowed further, but this wasn’t echoed by FX markets as other market dynamics weighed stronger for currency markets on Monday.

Macron’s victory removes a tail risk for financial markets, as evidenced by narrowing Oats spreads, but the euro doesn’t benefit from this as other market dynamics remain more prominent and political risks remain elevated.

The lack of reaction in currency markets is in line with our expectations. Not only were markets ignorant of a potential win by Le Pen (EURUSD risk reversals showed no increased hedging against EUR weakness), but a win by Macron also isn’t viewed as bullish for the euro per se as political risks remain elevated.

The legislative elections are held in June, which leaves an abnormal delay between the second round and legislative elections and increases the probability of the latter being used as a protest vote against President Macron. This is especially the case as many of the left-wing voters who voted for Jean-Luc Mélenchon in the first round were said to abstain or cast a blank ballot in the second round to protest against the current right-wing dominant nature of France’s political structure.

The near two-month gap between the second round and legislative elections now leave Macron open to criticism of illegitimacy by opposing parties ahead of the regional elections, which increases the probability of a cohabitation scenario arising. This could see a new government emerging of opposing party members, forcing Macron to compromise on his domestic agenda.

Macron’s large lead in the presidential elections suggest he still has a good chance of winning the majority in the legislative elections, but both a left- and right-wing majority remain a possible option and a surprise cannot be ruled out. If this is the case, a left-wing majority is possible, but not the most likely outcome.

On the right too, there are attempts to bring together the right-wing and far-right elected representatives opposed to Macron to form a group in the national assembly. A majority for this group seems unlikely at the moment. Macron's large lead in the presidential election suggests that he still has a good chance of winning a majority. Nevertheless, depending on the upcoming inter-party negotiations, a surprise cannot be ruled out.
 
In the near-term, the euro will likely continue to be under pressure from a strengthening US dollar, especially ahead of next week’s FOMC meeting where a 50bp hike is fully priced in. However, over the more medium-term, there is more room for the euro to strengthen if overall communications from the European Central Bank shift and take on a more hawkish stance.

The main hawks at the ECB have already spoken up to the media in recent days to discuss the possibility of rate lift-off in July, but only an echoed signal from more dovish members would signal an overall shift in tone and would be more sustainably supportive for the euro.