Political Uncertainty Impacts Euro as Emerging Market Currencies Decline

Key Takeaway

• Emerging market currencies fell 0.3%, with the Hungarian forint and Polish zloty notably weakening, while the South African rand rose 0.9%.
• The euro dropped to a one-month low at $1.0738 amid political uncertainty following French President Macron's call for legislative elections.
• Investors are shifting to local bonds and relative-value currency trades in emerging markets, favoring Turkish assets and frontier markets like Egypt.

Emerging Market Currencies Decline

Currencies in most of the world’s developing economies weakened as political risks heightened following a series of high-profile elections. The MSCI gauge for emerging currencies declined by 0.3%, led by Eastern Europe, with the South African rand being the notable exception. The rand rose 0.9% against the dollar, paring some of its losses from the previous month’s inconclusive ballot. Asian tech stocks also pulled the equity benchmark lower.

The Hungarian forint lost 0.8% to the euro, while the Polish zloty weakened by 0.4%. The euro itself fell to its lowest in a month after French President Emmanuel Macron called a legislative vote following a defeat in the European Parliament election. "The prospects of Marine Le Pen’s far-right party doing well in the French election and the potential impact on Europe’s commitment to supporting Ukraine may well demand a risk premium on central and east European currencies this month," said Frantisek Taborsky, a strategist at ING Bank NV.

Euro Faces Political Uncertainty

The euro slid to its lowest in a month against the dollar after French President Emmanuel Macron and German Chancellor Olaf Scholz were trounced by far-right parties in European elections. The euro fell 0.6% to $1.0738 after Macron announced the election, which will take place over two rounds starting June 30. This has led to increased volatility, with a gauge of euro volatility over the next month surging to its highest since mid-May.

"The prospect of a French election with a highly opaque outcome gives no reason to buy the euro," said Peter Kinsella, global head of FX strategy at Union Bancaire Privee Ubp SA. "We can expect euro underperformance for the next three weeks." The common currency could fall to $1.05 in the third quarter, according to Alvin Tan, a strategist at RBC Capital Markets in Singapore. "Political risks are rising for the euro again," he added.

Emerging Market Investment Shifts

Emerging-market investors are turning to local bonds and relative-value currency trades in the aftermath of election shocks. Ashmore Plc and Ninety One are among those adding to positions in local debt, particularly in frontier markets. "We’ve been increasing the frontier risk, through both local bonds and FX derivatives," said Christine Reed, a portfolio manager at Ninety One. "We like the story in Egypt, we like some of the stories in smaller Latin American names."

Turkish assets are also emerging as a favored bet. "It’s a fundamental story supported by the central bank, which has hiked a lot and the inflation trajectory is coming down," said Valentina Chen, co-head of emerging-market debt at Mackay Shields in London. The Mexican peso, which had posted the worst week since the onset of the pandemic, rebounded slightly on Monday as President-elect Claudia Sheinbaum’s coalition fell short of the supermajority needed to make changes to the constitution.

Street Views

• Frantisek Taborsky, ING Bank NV (Bearish on central and east European currencies):

  "The prospects of Marine Le Pen’s far-right party doing well in the French election and the potential impact on Europe’s commitment to supporting Ukraine may well demand a risk premium on central and east European currencies this month."

• Razia Khan, Standard Chartered Bank (Cautiously Optimistic on South African rand):

  "The rand appears to be supported for now by market optimism over the likelihood of a government of national unity and the potential reduction of political uncertainty, although risks remain in domestic politics as well as global factors such as the upcoming US inflation data and its impact on Federal Reserve’s rate outlook."

Management Quotes

• Cyril Ramaphosa, President of South Africa:

  "The country’s next administration must sustain policy reforms aimed at accelerating economic growth."