France out of the euro? Small chance with big consequences

The turmoil in the currency world is increasing sharply in the run-up to the French presidential elections. The sharp fall in the euro over the past two weeks is the start of a turbulent time in which it is wiser to err on the side of caution.

The euro/dollar exchange rate shot up to the highest level since the US presidential election in the second half of March. The euro had a tailwind after better-than-expected economic growth figures. Some economists also hinted that an ECB rate hike was imminent.

Since then, sentiment has completely turned. The euro has fallen by more than 2 percent within 3 weeks. ECB President Mario Draghi emphasizes that an interest rate hike is still a distant prospect. That depresses the euro. In addition, attention has shifted to the French presidential election, which could herald an uncertain future for the euro.

11 candidates and 2 rounds
The first round of the French elections will take place on Sunday, April 23, 2017. There will then be 11 candidates. If none of those candidates manage to get a majority of the votes, a second round will be held 2 weeks later (on 7 May) with the 2 candidates who received the most votes in the first round.

The chance that the second one will come around is quite high. Since the most popular candidate, according to the polls, can count on barely more than a quarter of the vote. The reformist Emmanuel Macron (25,3 percent) has a slight lead over the populist Marine Le Pen (25,1 percent).

Back to the franc
While the differences in the first round may be very small, Macron is the clear favorite in the second round. Polls show that Le Pen is heading for less than 30 percent of the vote. According to the pricing on options markets, that percentage is even closer to 20 percent.

The vast majority of French people probably want to avoid a prime minister who wants to exchange the euro for the franc as soon as possible. Think tank ''Institut Montaigne'' calculates that the economic damage, if it leaves the euro, could damage France as much as more than 180 billion euros.

World of difference
However, the chance is not excluded that Le Pen will eventually win. For example, the polls were also significantly wrong with the Brexit referendum and the American elections.

In foreign exchange markets, a Le Pen win causes the euro to fall until it is worth as much as the dollar. On the other hand, if Macron wins, the euro/dollar rate could move towards $1,10. The difference between 1,00 and 1,10 dollars does not seem very big at first glance. However, in foreign exchange markets, where price differences are expressed in pips (four decimal places), that is a night and day difference.

Protection has a price
These kinds of fluctuations also affect companies that do business across borders. A good order is a lot less attractive if the actual yield is 10 percent lower due to currency fluctuations. That affects the profit margin considerably. It is more important than ever for companies to hedge against currency movements. Due to the growing uncertainty in the run-up to the French presidential elections, the price of that insurance has risen considerably.

The most important lesson from 2016, however, is that it is wiser to hedge the risk even at a high price, than to hope with blind faith for a favorable outcome. It is not without reason that the major parties have been trying to protect themselves against new shocks on the foreign exchange market for some time now.

Lawrence Martins

Laurens Maartens is a currency expert at the Dutch Payment and Exchange Company (NBWM). Maartens analyzes current currency developments and also provides lectures and training in the field of currency management.

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