Euro Declines Amid Political Turmoil in Europe, Traders Anticipate Further Volatility

Key Takeaway

• The euro fell 0.6% to $1.0738 amid political instability in Europe, with traders anticipating further losses and volatility.
• French markets were hit hard; the CAC 40 dropped 2.4%, and major banks BNP Paribas and Societe Generale declined over 4%.
• Broader European markets also reacted negatively, with the pan-European Stoxx 600 index slipping 0.9% and concerns rising about long-term euro stability.

Euro Declines Amid Political Uncertainty

The euro experienced a significant decline, reaching its lowest point in a month against the dollar, following political upheaval in Europe. The currency fell 0.6% to $1.0738 after French President Emmanuel Macron and German Chancellor Olaf Scholz faced substantial losses to far-right parties in the recent European elections. Macron's response was to call a snap legislative election, set to begin on June 30, which has led to increased volatility in the markets. Options markets indicate that traders are anticipating further losses and larger swings for the euro.

Roberto Cobo Garcia, head of G-10 FX strategy at Banco Bilbao Vizcaya Argentaria SA in Madrid, noted, "If there is something that we learned in the peripheral crisis is that the euro does not like political instability." He added that volatility, which was surprisingly low at the beginning of June, is expected to rise due to the uncertain political and geopolitical scenarios. A gauge of volatility in the euro over the next month surged to its highest since mid-May, with traders turning bearish on the currency at the fastest pace in over a year.

Impact on French Markets

The political turmoil has also had a pronounced impact on French financial markets. The CAC 40 equity index in Paris dropped 2.4%, with major French banks such as BNP Paribas and Societe Generale seeing declines of 4.23% and 5.15%, respectively. The premium investors demand to hold 10-year French bonds relative to their German equivalents rose to the highest level since January. The euro also fell 0.5% against the British pound to 0.8457 pounds, marking the biggest daily drop since March 8.

Stefan Koopman, senior macro strategist at Rabobank, commented on Macron's decision to call a snap election, stating, "His [Macron’s] courage is undeniable, we’d give him that, but it seems like doubling down on a bet after a poor performance. Investors don’t share Macron’s risk appetite." The French losses had a ripple effect across the euro area, with the pan-European Stoxx 600 stock index slipping 0.9%.

Broader European Market Reactions

The broader European market also reacted to the political developments. The euro fell 0.4% to $1.0758, and European equities and French bonds retreated. BNP Paribas SA and Societe Generale SA led the losses among stocks in Paris, each tumbling more than 6%. The political uncertainty has raised concerns about the long-term outlook for the euro, with strategists focusing on the potential impact on France's economic outlook and the broader European resolve toward closer fiscal and financial integration.

Vincent Mortier, chief investment officer at Amundi, stated, "Markets will be prudent but not panicked. French stocks will likely underperform European peers to some extent and the spread between yields on French and German sovereign debt could widen modestly." Meanwhile, Sonja Marten, head of FX and monetary policy research at DZ Bank, noted that a win for Marine Le Pen could impact the euro negatively, especially if it adds to strife within the Eurozone.

Street Views

• Roberto Cobo Garcia, Banco Bilbao Vizcaya Argentaria SA (Bearish on the euro):

  "If there is something that we learned in the peripheral crisis is that the euro does not like political instability. Volatility was surprisingly low at the beginning of June but it should rise given the uncertain political and geopolitical scenarios."

• Peter Kinsella, Union Bancaire Privee Ubp SA (Bearish on the euro):

  "The prospect of a French election with a highly opaque outcome gives no reason to buy the euro. We can expect euro underperformance for the next three weeks."

• Valentin Marinov, Credit Agricole (Bearish on France’s economic outlook and European integration):

  "This could be seen as a blow to the nascent euro-positive sentiment that has started to dominate FX markets in recent weeks. Any renewed widening of peripheral sovereign yield spreads to bunds could be seen as negative for the euro."

• Alvin Tan, RBC Capital Markets (Bearish on the euro):

  "Political risks are rising for the euro again."