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EUR/USD, CAC 40: French Election Risks Rising, But Under-Priced for Shock Scenario

EUR/USD, CAC 40: French Election Risks Rising, But Under-Priced for Shock Scenario

Justin McQueen, Strategist

French Election, Euro, CAC 40 Analysis and News:

  • French Election Risks Rising, but still under-priced
  • How Much is Priced in for the upcoming election?
  • Low Euro Vol Reflecting Market Complacency?
  • Trading impact for the Euro
  • Rising Real Yields to Increase Gold Headwinds

French Election Risks Rising, but still under-priced

As we draw closer to the first round of the French election, markets are starting to price in an election risk premium. As evidenced by yesterday’s session with the CAC 40 the underperforming index. Meanwhile, Bund/OAT spreads are the widest in 2 years. However, in light of tighter polling between Macron and Le-Pen in recent weeks, French election risks are still somewhat under-priced in comparison to 2017.

CAC 40 Chart: Daily Time Frame

EUR/USD, CAC 40: French Election Risks Rising, But Under-Priced for Shock Scenario

Source: Refinitiv

French Election Polling

In both the first and second round voting, the momentum has been with Le Pen. The most notable observation is how narrow the lead is for Macron in the second round. Back in 2017, the second round polling average was around 60-40, this is now 54-46. Although, recent polls (Harris Interactive) have shown a much tighter second round runoff with Le Pen notching her highest ever score at 48.5%. Therefore, the risk of a shock upset has heightened, which will be even greater should there be reports of a low turnout.

2022 vs 2017 voter intentions

EUR/USD, CAC 40: French Election Risks Rising, But Under-Priced for Shock Scenario

Source: Politico

How Much is Priced in for the upcoming election?

Ahead of the French election in 2017, the Bund/OAT spread on average was wider by 70bps, hitting a high of 82bps on the eve of the first round voting results. Currently, the spread is wider by around 52bps, yet the risk of an upset according to opinion polling is much higher than 2017.

German-French 10Y Bond Spread

EUR/USD, CAC 40: French Election Risks Rising, But Under-Priced for Shock Scenario

Source: Refinitiv

Similarly, across vol markets, EUR/USD implied volatility is also relatively tame in comparison to 2017. Now while, it was clear that Le Pen was very much anti-EU, and thus the populist trade was embedded in the currency. Should Le Pen perform strongly in the first round, volatility will pick up ahead of the second reflecting greater market uncertainty for the Euro.

Low Euro Vol Reflecting Market Complacency?

EUR/USD, CAC 40: French Election Risks Rising, But Under-Priced for Shock Scenario

Source: Refinitiv

Trading impact for the Euro

That being said, while I expect a reduction in Euro exposure heading into the weekend. The lack of embedded risk premium in the Euro, suggests to me that should Macron post a comfortable victory in the first round, the relief rally will be much less significant vs what we saw in 2017. In turn, risks for the Euro are asymmetrically tilted to the downside. For now, the bias remains to fade bounces in the Euro vs USD and commodity currencies.

EUR/USD, CAC 40: French Election Risks Rising, But Under-Priced for Shock Scenario

Source: Refinitiv

Rising Real Yields to Increase Gold Headwinds

As I have mentioned previously, gold traders should be keeping a close eye on real yields, which has continued to edge away from deep negative yields. As such, this increases the headwinds for the precious metal. However, the key level to watch is 1880, where unless gold breaks below, the chart looks neutral for now.

Gold vs US 10Y Real Yields

EUR/USD, CAC 40: French Election Risks Rising, But Under-Priced for Shock Scenario

Source: Refinitiv

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