France votes and the euro loses

The euro is taking a big hit due to the prospect of parliamentary elections being held in France next month. Before that happens, the focus in the currency markets shifts to the American interest rate decision.

Currency markets were briefly dominated by the first European interest rate cut in five years. However, less than a week later, that interest rate move feels like a distant memory. The main reason is the significantly increased political uncertainty that has arisen after the European Parliament elections. In France, the major victory of Rassemblement National prompted Prime Minister Emmanuel Macron to call for elections. The far-right party garnered 31.4% of the votes, more than double the votes received by Renaissance. Macron's party only received 14.6% of the votes. Currency markets quickly turned their attention to what the arrival of a new government means for French finances.

French treasury running low
France's national debt is roughly equal to the size of the economy, also known as GDP. This puts the country in a significantly worse position than, for example, Germany and the Netherlands, where this ratio is around 60% and 50% respectively. Furthermore, money flows out of the French treasury much more than it comes in. Last year, the budget deficit reached 5.5% of GDP. And since the country has been exceeding the 3% threshold for years, the European Union is on the verge of initiating an excessive deficit procedure. With the prospect of a new government possibly taking an even looser approach to budget policy in a few weeks, the pressure on the euro is increasing.

American job market in full swing
The euro has dropped by over 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 the United States added a whopping 272,000 new jobs last month. Prior to the data release, a financial news service conducted a survey among 77 economists. None of them had anticipated such a strong employment figure. Low unemployment gives the Federal Reserve room to refrain from adjusting the policy rate for the time being. The first opportunity for this adjustment will actually come next Wednesday.

All eyes on dot plot
It would be very unusual for the Federal Reserve to adjust the policy rate at that time. Currently, financial markets are assuming that the first interest rate cut will not come until the fall. The forecast that the Federal Reserve releases through the so-called dot plot can have a significant impact on the direction of the dollar. If the plans for an interest rate cut are pushed back even further, it becomes more attractive to hold assets in dollars again. The interest rate differential with the euro - where the European Central Bank is heading towards more rate cuts in the fall - seems to be widening. In the run-up to the French elections, the dollar certainly has a strong tailwind.

Joost Derks

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

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