The euro after France's first round
Roger Blitz and Petr Krpata of ING, discuss what is next for the euro. As a Le Pen victory appears unlikely, markets are focusing on the ECB - the expected QE tapering should take the euro higher
Produced by Alessia Giustiniano. Filmed by Petros Gioumpasis
Markets hailed Sunday's first round in the French presidential election, which has established centrist candidate Emmanuel Macron as fervent favourite to beat Marine Le Pen in next month's runoff. So what does this mean for the euro and for other countries? With me to discuss this is Petr Krpata rate strategist, at ING. Petr, this is a very strong, bullish market reaction to the Sunday vote.
Indeed it is, and we think it is for good reasons. Ahead of the vote, there was a huge uncertainty whether the far right and far left will be together in the final, because the margin between the four candidates was only 3.5%. Hence the relief rally. We've seen, as it is shown on this graph, implied volatility on the euro dollar falling sharply, meaning that the market is less concerned about the future and the risk to the euro.
Your second chart reflects how other currencies will react and have reacted.
Precisely, and on this chart, and this was created in ING, we show the vulnerability scorecard of global currencies to eurozone-specific risk. On the left hand side the most vulnerable currency, Central and Eastern Europe. On the right hand side the least vulnerable--
The haven currencies like the yen.
Precisely, and the yen. And the price action after the Sunday vote inversely reflected this chart. Top performers Central and Eastern European currencies and Scandinavians-- the worst performers safe haven yens. And the reason is because this massive eurozone-specific risk is out of the way. Good news for Europe, for the euro, for Scandinavian currencies, for Central and Eastern Europe--
But are we going to see the euro going higher because of the second round if Macron ends up winning?
We don't think so. And the reason is that we think that most of the risk premiere pricing is now, by and large, over. On the first chart you have seen that the impact was that it fell sharply.
Rather what we are think is much more important is the fact that it looks like that Macron is going to win because the margin is too large, vis-a-vis Le Pen, 20%. This actually means that global investors will be now allowed to focus on the next big theme in FX markets.
And we have the European Central Bank meeting on Thursday, so what is the prospect of driving the euro higher? And what lessons can we learn from the US tapering-- that's your next job.
Yes that indeed is. We think that the announcement of ECB QE tapering, or the signal, will the next key catalyst for a move in euro dollar higher. We don't think this will happen this week. We think this is more of a September meeting story. But, as this chart shows, there is still one huge implications of the very moment when the ECB will announce QE tapering. Forward looking markets will price it in actually ahead of the event.
And this is what we see here. The red line shows the level of a 10 year US treasury yield. The blue line shows the monthly pace of Fed bond buying. What you see here that the US treasury yields started sharply increasing way before the Fed started actually tapering. It started increasing when Chairman Bernanke at that time pointed at the idea or signalled the idea QE tapering.
All depends of what Mario Draghi says. And finally, your chart about the value of the euro in general there is a lot of room for the euro to rally further, is that right?
That's true. And as this chart shows, misvaluation or difference between the real euro dollar and its fair value. When the percentage number is negative it suggests the euro dollar is undervalued. When positive, it is overvalued. What you see here at this point is that the euro dollar is materially undervalued. And the very moment when the ECB will signal the QE tapering, or the market will start positioning for it, we think that this will be a catalyst for this huge euro dollar undervaluation to correct.
If she doesn't win, if Miss Le Pen does not win, what can still stop this rally at the end of the day?
At the end of the day it is all about the ECB. If the ECB, for whatever reason, decides to continue in its asset purchases-- either because too low inflation, inflation will go below 1%, or the growth will collapse-- then there'll be no euro dollar rally. Equally, and on the other side of the equation or continent if you will, if the trumpflation trade backs into life, and markets will be pricing much higher yields in the US better economic growth prospects, and much hawkish Fed. Again this suggests that the euro dollar will not go higher. But this is not our base case.
Let's see what the ECB says on Thursday. Petr Krpata thank you very much indeed.