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Euro to Weaken, Dollar to Strengthen Once Euro Area Stress Eases

Euro to Weaken, Dollar to Strengthen Once Euro Area Stress Eases

By    |   Monday, 24 April 2017 10:58 AM

The first round of the French Presidential election results show French voters have backed the centrist Emmanuel Macron and the far right Front National Marine Le Pen for the final round of the French presidential election that takes place within two weeks on Sunday, May 7 and which leaves the country literally divided in two ideologically completely opposite parts, which, possibly, won’t help the country out of its actual slump in the foreseeable future.

It is also important to take notice that the two mainstream political parties, Les Républicains and the French Socialist Party, will not participate it the second round of the presidential race, which will be the first time that happens in decades and that raises significant questions about the effectiveness and solidity of the next French government under probably, as things stand today, Mr. Macron.

Besides all that, it was remarkable how the results of this 1st round of the French Presidential election came out as opinion polls had predicted.

But please take care, this should not be quite as surprising as it could seem to be, especially when we look back on how the political opinion polls got it all so wrong with the UK referendum or the Dutch election, when, and this is important to keep in mind, the turnout was not as was expected.

A higher turnout with people who do not normally vote is something that opinion polls do not do a good job of capturing. The French turnout was normal and in line with expectations.

So, the opinion polls were broadly right as was expected (by insiders) them to be.

This has allowed markets to price in the second round being in line with the opinion polls, which project a Macron victory.

Of course, there is still two weeks to go and more opinion polls and the possibility of something game changing happening in the news flow, but for now markets are content to price assets on the basis of a roughly 20 percent lead to Macron.

So, the legitimate question is “Why is the euro not stronger?”

The euro has rallied and fundamentals supported this, but it has not held on to its initial gains.

It’s worth coming back to that central point on what defines finally the strength or not of the euro, which is, and that many international investors, which includes U.S. investors, tend to forget, is that the price of the euro is determined by European investors themselves.

Never forget that the euro area is a current account surplus bloc and therefore for having a weaker euro, the euro needs domestic investors to sell their own currency.

On the contrary, the U.S. is a chronically current account deficit country and therefore for having a stronger dollar you need foreigners to buy the dollar.

Euro area investors tend also to understand Euro area political risk better than foreign investors, and domestic investors in the Euro zone have repeatedly told surveys that they were not too concerned about the French election, hence the more muted response.

If logic applies, which is of course not such a sure thing in this abnormal world, then there should be a somewhat stronger euro, or rather there should be a somewhat weaker dollar in the coming months while in the end, the French elections may not be such a dramatic catalyst after all.

So, for now at least in FX markets, the euro is likely to see something of a modest short-term relief bounce, but then, we also have the fundamental long-term divergence between the monetary policies of the Fed and the European Central Bank (ECB) that should continue to handicap, again albeit limited, the euro against the dollar.

Alongside of all this it is also a fact that the euro has become a funding currency for carry trade operations now since several years. 

Now, and this could be somewhat surprising, the euro being us as a carry trade vehicle has led to a strengthen of the euro during periods of stress in the Euro are and vise versa.

Therefore, we shouldn’t be surprised to see a somewhat weaker euro and therefore a somewhat stronger dollar when stress in the euro area abates.

Among a lot of things, this week we’ll get U.S. GDP for the first quarter, which will be subject to the first quarter seasonable adjustments.

Long-term investors could do well keeping in mind there is a risk of a weaker a GDP figure being reported than is actually happening in reality.

Etienne "Hans" Parisis is a bank economist who has advised global billionaires and governments on the financial markets and international investments.

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Therefore, we shouldn’t be surprised to see a somewhat weaker euro and therefore a somewhat stronger dollar when stress in the euro area abates.
investors, gdp, economy, growth
Monday, 24 April 2017 10:58 AM
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