Euro falls as European politics add to market uncertainty

(Bloomberg) — Heightened political uncertainty in Europe is piling pressure on the euro.

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The single currency fell to a one-month low against the dollar after French President Emmanuel Macron and German Chancellor Olaf Scholz were defeated by far-right parties in European elections on Sunday. With the results leading the former to call an immediate legislative vote in the house starting June 30, options markets indicate traders expect more swings and further losses.

The concern is that the election result has also clouded the long-term outlook for the world’s second most traded currency, as it calls into question the prospects for greater integration and a united Europe. It is making trading more volatile as markets have been depressed over the past year.

“If there’s anything we learned in the peripheral crisis it’s that the euro doesn’t like political instability,” said Roberto Cobo Garcia, head of G-10 FX strategy at Banco Bilbao Vizcaya Argentaria SA in Madrid. “Volatility was surprisingly low in early June, but should increase given the uncertain political and geopolitical scenarios.”

A gauge of volatility in the euro over the coming month rose to its highest level since mid-May. Prices in the options market show that traders have returned to bearish the common currency at the fastest pace in more than a year, leaving sentiment at its most negative since April.

The euro fell 0.6% to $1.0738 after Macron announced the election, which will be held in two rounds in a battle with far-right rival Marine Le Pen. The vote could open the door to more influence from her National Rally party and undermine Macron’s ability to push through legislation. French bonds fell to push borrowing costs to their highest level this year.

“The prospect of a French election with a very bleak outcome gives no reason to buy the euro,” said Peter Kinsella, global head of FX strategy at Union Bancaire Privee Ubp SA. “We can expect underperformance of the euro for the next three weeks.”

Strategists have focused on the potential impact on France’s economic outlook in particular, with the country’s bank stocks sliding on Monday. Investors may also begin to question European resolve towards closer fiscal and financial integration, according to Credit Agricole’s Valentin Marinov.

“This could be seen as a blow to the nascent positive euro sentiment that has started to dominate FX markets in recent weeks,” said the French bank’s head of G-10 FX research and strategy. “Any renewed widening of peripheral sovereign yield spreads in the Bundes could be seen as negative for the euro.”

Bullish betting

The move comes shortly after leveraged funds returned to a net bullish position against the euro for the first time since August, according to the latest data from the Commodity Futures Trading Commission. The currency had strengthened about 3% from an April low before the widely telegraphed interest rate cut by the European Central Bank last week, as traders chose to focus on where policy could go next with inflation still high.

But now traders will also have to factor political uncertainty into their bets.

The common currency could fall to $1.05 in the third quarter, said Alvin Tan, strategist at RBC Capital Markets in Singapore. “Political risks are increasing again for the euro”.

–With assistance from David Finnerty, Masaki Kondo, Ruth Carson and Matthew Burgess.

(Updates prices, adds options details and analyst commentary.)

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