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How To Trade The French Election

By Kathy LienForexApr 21, 2017 15:56
How To Trade The French Election
By Kathy Lien   |  Apr 21, 2017 15:56
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By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.

If you are trading the euro, you need to be watching the election in France this weekend. While it is the first of two rounds with a final vote scheduled for May 7, the winner’s lead could set the tone for how European assets trade for the next few weeks. The race is coming down to 4 candidates – the far right Marine Le Pen, the independent Emmanuel Macron, the center-right Francois Fillon and the left-leaning Jean-Luc Melenchon who mounted a late-stage comeback to pull within striking distance of the other three. But with days to go before the vote, the race is still too close to call and that’s why it's so dangerous for the euro. Throughout this past week, the euro traded as if Macron was a sure win, which is a big mistake because even the polls show that the market is underestimating the possibility of a strong victory by Le Pen. The problem is that Le Pen and Macron couldn’t be any more different and depending on who wins, France will be put on very different paths. Good or bad, the world has gotten a taste of what this means with the U.S. election and the victory of Donald Trump. By the time some of you read this, the results from the election will be known, so instead of delving into who is the better candidate, we want to discuss a few possible scenarios:

BEST Scenario for EURO >> Macron and Le Pen earn the most votes & Macron wins with a comfortable margin

WORST Scenario for EURO >> Le Pen and Melenchon/Fillon earn the most votes & Le Pen wins with a comfortable margin

Now if Macron and Le Pen earn the most votes and Le Pen wins, the euro will fall with the extent of the decline determined by Le Pen’s margin of victory. The greater the margin, the greater the pressure on the currency.

As it is extremely difficult to predict the outcome of the election, the best way to trade the French Presidential election is to wait until the results are known. If the outcome is meaningful enough — meaning it creates enough fear or relief — the impact on the euro will last for days.

The French election should remain a focus for EUR/USD traders until May 7, but the European Central Bank’s monetary policy announcement on Thursday will also be a key driver of EUR/USD flows. Since the last monetary policy meeting we have seen widespread improvements in the labor market, consumer spending and economic activity. Although German economic activity is down slightly in April, the measures were up significantly from February (the last readings before the March ECB meeting). The measures for the Eurozone were up across the board, led by improvements in France. Unfortunately the central bank’s hands are tied because inflation is low with consumer price pressures easing further in March. At some point, the improvements in the economy will drive up prices but for the time being, subdued price growth allows the ECB to keep monetary policy easy. Aside from the ECB meeting, the German IFO, Eurozone confidence and inflation reports are also scheduled for release in the coming week, pitting politics against economics.

The U.S. dollar could take a backseat with no major U.S. economic reports scheduled for release until Friday. While USD/JPY has held up well in the face of weakening consumer spending, inflation and manufacturing data, the greenback struggled against European currencies this past week. A lot of that had to do with euro- and sterling-specific drivers but USD's general resilience can be attributed to the complacency of investors who believe that the recent disappointments in U.S. data changes nothing about the outlook for U.S. monetary policy. The Federal Reserve is still expected to raise interest rates again this year with the rate hike likely to occur in September rather than June. The Bank of Japan also has a monetary policy meeting in the coming week and according to Bank of Japan Governor Kuroda who spoke on Thursday, the current pace of bond purchases will continue for some time. Like the ECB, the BoJ struggles with low inflation so Kuroda is effectively promising a longer period of accommodative monetary policy. While U.S. new home sales and the Conference Board’s consumer confidence index are scheduled for release at the start of the week, the main event for the dollar will be Friday’s first-quarter GDP report. Unfortunately, the pace of growth is expected to slow given the weakness in retail sales and trade and if we are right, this could keep the dollar under pressure.

One of the biggest stories this week was Prime Minister May’s decision to call snap elections in June. This announcement was completely unexpected as her office denied speculation as recently as Easter Break and it goes against her previous vow to not call another election before 2020. The announcement sent sterling soaring more than 2% on Tuesday but since then, the currency has struggled to extend its gains. The problem is that her bold move is not without risks. Of course she wouldn’t have made the move without some confidence in her victory and May is very popular despite the country’s division over Brexit. In a poll taken shortly after her announcement, May’s party had a comfortable 21-point lead. Her goal is to shore up political support for the decisions that will need to be made over the next few months. As May said in her speech, “The country is coming together, but Westminster is not.” Sterling’s reaction to the news is a reflection of the market’s confidence in the Conservatives who they believe will sweep the votes. If she succeeds like the market expects, the support of her people gives her strong negotiating power with the European Union. Even though retail sales fell sharply in March, data in general has been relatively healthy, allowing GBP to recover from its lows following the report. That said, the softness in retail sales and trade points to a weaker first-quarter GDP report.

The Australian, New Zealand and Canadian dollars had a mixed performance. While AUD and CAD experienced losses, NZD rose slightly versus the greenback. The biggest loser was the loonie, which was dragged down by lower oil prices and softer inflation. Consumer price growth failed to accelerate in April and that caused the year-over-year CPI growth rate to slow to 1.6% from 2%, the weakest pace of growth in 3 months. This softer inflation report was just what USD/CAD needed to break above 1.35 for the first time in 5 weeks. Canadian retail sales and GDP are scheduled for release next week and while the labor market is improving, retail sales also rose strongly in January, so there could be some payback in February. The Australian and New Zealand dollars only experienced modest losses. Both currencies were supported by stronger Chinese retail sales, industrial production and GDP data but AUD struggled on the back of dovish RBA minutes and lower copper prices. Because of volatility, the central bank wanted to look past the healthier jobs report. Australian consumer prices are scheduled for release next week and the CPI report is generally a big market mover for AUD. In New Zealand, on the other hand, data has taken a turn for the better. Service and manufacturing activity is up thanks in part to rising dairy prices and of that bodes well for next week’s New Zealand trade balance.

How To Trade The French Election

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How To Trade The French Election

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