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Investors’ itch to switch to euro foiled by Le Pen

Burkhard Varnholt last week paid €14 for lunch for two people at a smart restaurant in Berlin. “The euro is so cheap,” says Credit Suisse’s deputy chief investment officer.

It is cheap because of one factor: Marine Le Pen.

In normal circumstances, the euro would be trading a lot higher on the back of the eurozone’s record current account surplus, an unemployment rate at its lowest in nearly eight years, an economy recording 14 consecutive quarters of growth, business confidence at a five-year high and inflation hitting 2 per cent for the first time in four years.

However, the prospect of the Front National leader Ms Le Pen securing an unexpected victory in the French presidential election leaves investors having to resist scratching what’s becoming a persistent itch: ploughing into the euro.

Not only is the euro becalmed, but yields on two-year German debt are at an all-time low — a market that has become “the parking lot of Eurosceptics”, says Mr Varnholt.

Which poses this scenario — if she were to lose, would the market throw its weight behind the euro? Most definitely, say investors and analysts. “It will happen faster than you can watch it,” Mr Varnholt adds. “The moment investors change their mind, the euro will go flying.”

In which case, is anyone brave enough to get ahead of the market and buy the euro in anticipation of her defeat?

Some of this is happening, says Max Kettner, a cross asset strategist at Commerzbank. Yes, the market is worried about the risk of a Le Pen victory, as seen in the swings in three-month implied volatility and other measures, which currently suggests hefty hedging by investors against a sharp fall in the euro.

“But European political risk is very much a well-known fact and once we get a bit of relief, these extreme moves are typically being reversed — and that’s what we see right now,” says Mr Kettner.

“Once there is hope of Le Pen’s chances slipping, there is definitely more willingness to buy euros ahead of the election.”

The health of the eurozone economy underpins their medium-term expectations. Business confidence is growing, not just in Germany but France and Italy, says Peter Schaffrik, macro strategist at RBC Capital Markets. “I do not think that there is ‘too much’ optimism,” he says.

The surprise is that political risk has had little impact on the economy and business confidence, says Didier Saint-Georges, managing director at Carmignac, so election defeat for anti-establishment parties could “clear the decks for a vigorous rebound in both stock prices and the euro”.

Valentin Marinov, forex strategist at Crédit Agricole, says a number of clients in northern Europe and Asia are bullish about the euro over the next six to 12 months. “It may be indeed tempting to buy the euro now,” he says.

There are reasons to hold fire, though, and they extend beyond the election prospects of Ms Le Pen.

First, says Mr Marinov, the dollar is well supported by the strength of the US economy and rising US interest rate expectations. Second, investors are scarred by their experiences last year with polling predictions for the EU referendum in the UK and the US election.

Third, victory for establishment parties in the Netherlands and France may not prevent long-lasting damage to investors’ euro sentiment.

Support for the euro and the EU are at historic lows in some parts of the region, and with expectations of Italian elections in early 2018, European political risk is not going away anytime soon.

Fourth, the European Central Bank looks to be in no hurry to ease monetary policy. The euro has naturally been sensitive to the ECB’s QE pronouncements and, while tapering of its asset purchases will have to happen at some point, analysts are divided about the timing.

ECB president Mario Draghi gave a brief boost to the euro at Thursday’s press conference, lowering its “sense of urgency” around monetary policy and raising growth and inflation targets.

But he will not be rushed, says Mr Schaffrik. “There is pressure [to taper] but there has been pressure all along. The core decision makers around Mario Draghi intend to keep the QE tap on until inflation is where they want it to be.”

Nor have euro-watchers allowed economic strength to gloss over fundamental weaknesses in the eurozone. Structural reforms remain on the wishlist of EU leaders, while the clean-up of the banking system is slow-moving.

These shortcomings will continue to hamper growth in large parts of the currency bloc, says Mr Marinov, which could mean that “the public discontent with the current political and policy set-up, which includes the monetary union, is here to stay”.

That suggests that any post-election boost to the euro starting in the second half of 2017 may be shortlived.

European political risk is making it difficult for investors to prise open the window of euro-buying opportunity. Once opened, it may shut again fairly swiftly.

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