Foreign exchange markets are now firmly fixated on France’s election with traders trying to gauge the various scenarios that the vote’s outcome could deliver.
The potential for big moves over coming days and weeks is large considering how narrow the opinion polls are and the uncertainty that this field of candidates presents.
After all, the favourite is an independent, the once-favourite is battling to stay out of prison and the next two potentials occupy the far-left and far-right of the political spectrum.
And, the average polling error for the first round of past French elections has been six percentage points, suggesting that the scope for a surprise relative to the consensus expectation of a Macron / Le Pen run-off remains high.
The big risk for the Euro is however a Marine Le Pen victory owing to her desire to take France out of both the Eurozone and European Union.
The movement of the Euro over coming days will therefore likely be a function of her success in the vote.
Goldman Sachs say they would expect such a revision to be very sizeable and persistent if the odds of her presidency increase beyond 50%, and if she makes a referendum to pull France out of the currency union a central point of her campaign between the first and second rounds – a dynamic that would clearly increase downside risks for the Euro.
The probability that investors assign to a break-up of the Euro area (as captured by the Sentix index) has declined from 25% in February to 18% in March – a period over which the odds of a Le Pen presidency have declined from around 35% to 25%.
“A strong endorsement of Ms. Le Pen in the first round would likely lead investors to reassess Euro break-up risk to the upside. We would expect such a revision to be very sizeable and persistent if the odds of her presidency increase beyond 50%,” says Ardagna.
To gauge how an increase in Eurozone break-up risk maps onto moves in the Euro, Goldman Sachs estimate the betas of different EUR crosses to changes in the Sentix indicator that measures the probability that investors assign to a break-up of the Euro area over the next 12 months.
A beta is a measure of the volatility, or systematic risk, of a currency pair in comparison to the market as a whole.
Should the probability of a Eurozone breakup increase from the current 19% level to 73% (which was the level reached in July 2012) Goldman Sachs estimate:
EUR/USD could depreciate by about 5% and trade close to 1.02, EUR/JPY could move to 111.5 and EUR/GBP to 0.82, from current levels.
EUR/GBP at 0.82 equates to 1.2195 in Pound to Euro terms. Considering that they see EUR/USD falling close to parity we would suggest this is quite a benign move in EUR/GBP.
We would imagine that the forecasting methods have not accounted for the rally in Sterling seen since Prime Minister May called a June 8 election.
Conversely, a reduction in break-up risks of the Eurozone to 10% would lead to a slight appreciation of the EUR versus the major G-10 currencies.
“Should Ms. Le Pen fail to make it to the second round (which would lead to a decline in the odds of her being elected to 0, from the current level of 23), EUR/USD could appreciate by around 5%, reaching around 1.13,” says Ardagna.