INSIGHTS • 12 JUNE 2024
Is this the beginning of the end for the euro?
Marc Cogliatti, Head of Capital Markets EMEA
Since Validus’ inception in 2010, the question of the sustainability of the euro project has lingered in our, and some of our clients’, minds. The European debt crisis of 2013/14 marked a peak in these questions, and Brexit along with the rise of populism in 2016 reignited the debate. In recent years, concerns about the future of the European Union and the single currency have subsided, but the rise of Marine Le Pen’s Rally National party and Germany’s AfD’s gains in the recent European Parliamentary elections have triggered concerns once again.
Despite broadly matching market expectations, Emmanuel Macron’s surprise snap election for the end of the month has shaken things up. This move is likely an attempt to win back some confidence and encourage the other centrist parties to rally around him and help stall the advance of Le Pen.
In terms of market reaction, the French 10-year bond yield is up ~20bps, while the German benchmark is up 4bps. Meanwhile, the euro is down 55bps against the dollar and down 48bps against the pound.
Although Macron’s actions spooked the markets on Monday morning, there are a few points to consider:
- EU election results: the Centrist majority holds 56% of the votes and thus nothing changes for now. The EU legislative process will continue to focus on promoting defence integration and boosting competitiveness. While the right-wing’s advance was in line with market expectations, the fact that it came from the powerhouses that are France and Germany is somewhat concerning. Voter turnout was approximately 51%, similar to 2019, indicating that recent geopolitical issues haven’t mobilised more voters.
- Bond market concerns: while French yields have spiked (see chart below), the spread over the German benchmark remains less than half the spread seen in Italian yields. This suggests a bond market crisis is unlikely, and any concerns about the stability of the wider Eurozone project seem farfetched at this stage.
- Euro under pressure: the euro was already on the back foot having closed last week under pressure following an ECB rate cut and a much stronger than expected US employment report, indicating rates elsewhere, particularly in the US, are likely to stay higher for longer. Meanwhile, ECB President Christine Lagarde reiterated that the ECB is not following a pre-determined path, suggesting it may not cut rates as aggressively as anticipated.
Chart 1: French – German Spread
Source: Bloomberg
Looking elsewhere for indicators on sentiment, the options market has shifted to place a premium on EUR puts over EUR calls (i.e. it is more expensive to protect against a shift lower in EURUSD than it is to get the same level of protection against a move higher). However, as the chart below shows, the relative cost is still lower than it was in April when Fed Chair Jerome Powell first hinted that the Fed might not cut rates as aggressively as anticipated.
Chart 2: EURUSD Risk Reversal
Source: Bloomberg
So, is this really the beginning of the end for the euro? The idea that this latest set of European election results could signal this seems a little premature. After all, Europe has operated with a far-right government in Italy for some time now and, despite some instability elsewhere (e.g. Belgium and Netherlands), Eurosceptics remain a minority.
Regarding our euro outlook, we see no reason to dramatically shift our forecasts. We’ve maintained a mildly bearish view on EURGBP and while it centres around the theory that GBP is cheap, the latest news only strengthens this perspective. Meanwhile, our bullish EURUSD forecast was (and still is) based on the premise of a broadly weaker dollar rather than optimism about the euro. While recent developments may temporarily stall a move higher in EURUSD, we expect dollar weakness to prevail as the year progresses.
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