It is tricky to project asset prices over a three-month horizon at the best of times, never mind during a pivotal election in one of Europe’s largest economies and during a time when the Fed is likely to prepare for its first rate cut later this year. Nevertheless, this forecast endeavours to provide the most pertinent factors to consider for the euro in Q3 with an indication of significant FX levels to keep in mind throughout.

French Snap Election: A Cause for Concern for Bond Market Investors

After a heavy defeat in the European elections, French President Emmanuel Macron announced a snap parliamentary election catching everyone off guard. Macron and his party have suffered a loss of support most notably since the pension reform protests and hasn’t quite managed to recover as the right-wing opposition, the National Rally (RN), and a consortium of left leaning parties appeared to fill the void.

Investors do not like uncertainty and a potential victory for RN could lead to standoffs when it comes to passing legislation as conflicts between the president and a RN majority in parliament could frustrate processes.

Evolution of Voter Preferences over the Last Three Years

Source: Politico, prepared by Richard Snow

OAT-Bund spreads have widened to familiar levels, underscoring the impact of a potential political headache. RN have been known to be critical of the European Commission and could push against policies passed down from Brussels, especially the issue of deficit spending – something that concerns the bond market given France already breaches EU guidelines of 60% debt to GDP ratio with its near 110% figure. If first round elections on June 30th reveal anything close to the winning margin at the European election, then the French risk premium is likely to rise further and history warns us that the euro tends to sell-off when debt-laden countries face higher borrowing costs. Contagion risk among periphery nations will be chief among investor concerns if the political landscape is headed for change.

French-German 10Y Bond Spread (Risk Premium)