France chooses, euro loses

The euro is taking a hit from the prospect of parliamentary elections being held in France next month. Before that happens, attention in the currency world will first shift to the American interest rate decision.

Currency markets were equally in the grip of the first European interest rate cut in five years. But less than a week later, that interest rate move feels like a distant memory. The main reason is the sharp increase in political uncertainty that has emerged after the European Parliament elections. In France, the big victory of Rassemblement National prompted Prime Minister Emmanuel Macron to call elections. The radical right party received 31,4% of the votes. That is more than twice as much as Renaissance. Macron's party received only 14,6% of the votes. On currency markets, attention quickly turned to what the arrival of a new government means for French finances.

French treasury is empty
The French national debt is approximately equal to the size of the economy, also known as GDP. This means that the country is in significantly less good shape than, for example, Germany and the Netherlands, where the ratio is approximately 60% and 50% respectively. Moreover, much more money flows out of the French treasury than comes in. Last year the budget deficit stood at 5,5% of GDP. And since the country has been above the 3% limit for years, the European Union is about to start an excessive deficit procedure. The prospect of a new government possibly coming in a few weeks that will be even less strict with budget policy is increasing pressure on the euro.

The American labor market is running at full speed
The euro fell by more than 1% against the dollar after the weekend. Just before the weekend, the currency also fell by almost 1%. This decline was caused by the report that no fewer than 272.000 new jobs were created in the United States last month. In the run-up to the publication of figures, the financial news service conducted a poll among 77 economists. None of these had taken into account such a strong job figure. Low unemployment gives the Federal Reserve the space not to tinker with the policy interest rate for the time being. The first chance for this will come next Wednesday.

All eyes on dot plot
It must be very strange if the US central bank then starts tinkering with the policy interest rate. Financial markets currently assume that the first interest rate cut will not come until the autumn. The forecast that the Federal Reserve releases via the so-called dot plot can therefore have a major influence on the direction of the dollar. If plans for an interest rate cut are pushed back even further, it will become more attractive to hold assets in dollars. The interest rate difference with the euro - where the European Central Bank is heading for more interest rate cuts in the fall - appears to be increasing. In any case, the dollar has a strong tailwind in the run-up to the French elections.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

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