Originally published by AxiTrader
On the day of the Brexit vote the British pound traded through an 1800 point range against the US dollar and more than 15 big figures against the euro.
That kind of volatility isn't expected for the euro in the wake of this weekend's first round of the French presidential election. But that's because markets still largely see Emmanuel Macron as the eventual winner and next President of the Republic.
Yet the chances of a surprise outcome have increased materially in recent weeks. And that means it's not only Euro and forex traders who will be watching the results closely in Asian trade Monday but markets across the globe.
Macron and Le Pen are still the front runners
In no small measure, euro is sitting quietly around 1.07 and the French/German 10 year bond spreads are in a little from their recent wides because in France - with its rolling polls and commitment by pollsters to age and income stratification as part of their process - the polls are viewed as less likely to provide the type of surprise that both Brexit and Donald Trump's election as US president did in 2016.
So neither the level of the euro or bond spreads are anticipating a shock.
But the price of buying protection against a shock has increased appreciably recently in forex markets. One month at-the-money implied volatility is off its highs. But at 12% it is extremely elevated relative to the 6% historical one month volatility.
So traders appear to be alert. But not alarmed.
But the polls have tightened.
Yet while a first round "win" for both far-right candidate Marine Le Pen and centrist candidate Emmanuel Macron seemed like a fait accompli just a couple of weeks ago polls have tightened considerably as the election this Sunday nears.
Source: Bloomberg.com - Screenshot
So while the polls still suggest that the highest probability remains that the second round presidential run-off election will be between Le Pen and Macron the rise of the left's Jean-Luc Melenchon, and the resurgence of former favourite Francois Fillon within striking distance complicates the outcome.
On top of the tightening of the race to what might be viewed a margin of error recent surveys suggest up to one-third of voters may still not be sure who they are going to vote for.
And as I wrote earlier this month that sets up a potential disaster scenario for markets if the "wrong" result happens in this weekend's election.
The WRONG result
"Wrong" is clearly in the eye of the beholder.
But in judging the possible election outcome this weekend - who will end up in the run-off election to be held on May 7 - the wrong result, or to put it another way the most destabilising result, is easily understood.
Both Emmanuel Macron and Francois Fillon represent the status quo for France in the Euro and in the EU. They are believers in the Euro project and want France to continue to play its current role in Europe from within the EU.
Marine Le Pen and Jean-Luc Melenchon represent a break from the EU and the Euro project. While they come from polar opposites in terms of the political spectrum they share a scepticism for the EU project.
Le Pen wants to leave the Euro and return to a French Franc, the value of which should more appropriately reflects French economic circumstance. Melenchon wants to try to renegotiate inside the EU but if all else fails, to leave the EU and Euro.
So there are a number of possible two candidate scenarios which will determine how markets react on Monday to the results of the first round election.
The disaster
A disaster for markets and the wrong result on that basis would be if Marine Le Pen and Jean-Luc Melenchon make it through to the next round. Because both are Euro-sceptics who want to challenge the EU's status quo markets are likely to react by selling French bonds, buying German bonds and buying dollars, yen, pounds, gold and anything else that is liquid against the Euro.
Indeed the head of the IMF, Christine Lagarde - herself a former French finance minister - said this week "with Le Pen it is undoubtedly the very ugly undercurrent of racism and anti-semitism. Yet with Melenchon, the problem is economic stupidity of a Venezuelan level of ghastliness".
Markets would have no choice but to take cover and react to such an outcome.
EUR/USD is likely to collapse quickly to 1.02/1.03.And it is not beyond the realms of possibility to see Euro under parity against the US dollar under such an outcome. French/German bond spreads could blow out toward 100 basis points or beyond.
The best possible outcome
Naturally, if it's a disaster for markets should Le Pen and Melenchon face off in the run-off election the corollary of that is if neither makes it through to the second round then it is likely the status quo candidates Macron and Fillon will be viewed as delivering consistency and stability for the EU.
1.10 would come into the frame quickly for the EUR/USD and it wouldn't be unreasonable to see the French-German bond spread contract below 50 basis points.
Fillon versus Le Pen or Melenchon
Francois Fillon was easily going to be the next President of France until recent months when his campaign went off the rails under a cloud of accusation of impropriety when it comes to employing family members.
A Fillon/Le Pen face off in round two of the election would likely see some mild tension exit the market as it would represent a resurgence by Fillon and likely mean he has momentum going into round two.
Euro and spreads would rally as a result.
Likewise, if Fillon faces Macron the message would be that both have solid momentum. That could be of some concern to markets given Melenchon has come from all the way at 11% just a few weeks ago and is a possibility to win the support of the socialists who currently hold power under president Francois Hollande.
While Fillon would still be expected to win tensions in markets would remain elevated and the Euro and bond spreads would likely react negatively.
Macron and Le Pen - the most likely outcome
If the polls are correct and we do end up with Macron and Le Pen facing off on May 7 then polling of second round intentions suggest that Macron should win that run off by an easy margin.
That will continue to restrain the Euro below 1.09 and keep bond spreads in the 60-65 point region. But should Le Pen surprise with a big margin in round one markets are likely to recalibrate their expectations that she will lose easily to Macron in round two of the election.
And if Macro does eventually prevail then - all other things equal - a big black cloud will have been removed over the EU, the Euro, and bond spreads.
And of course, if Macron faces Melenchon then it is likely the centrist candidate will win in the second round of voting. But again the very fact that Melenchon would come into the second round with momentum would restrain market ebullience at such a result.
A long-term look at the Euro
Since topping out above 1.60 in 2008 EUR/USD has been in a broad and gradual decline when viewed through the long lens of the monthly charts.
Back in 2015 this decline stepped into a lower range below 1.17 and in 2016 EUR/USD made a low just below 1.03. And for the last 12 months Euro has been in a shorter term decline with current parameters around 1.0150 and 1.10.
These levels provide the big levels to watch should a shock result - either positive or negative - eventuate.
Have a great day's trading.