Euro Drops 1.3%, Political Woes Drive 2024 Low Concerns

Key Takeaway

• The euro has dropped 1.3% against the US dollar, marking its worst two-day loss in two months due to economic and political factors.
• Political uncertainty from French President Macron's snap election call and ECB's eased monetary policy are driving bearish sentiment on the euro.
• European stocks, particularly French equities, have reacted negatively with the CAC 40 index down 2.1%, reflecting market concerns over political instability and economic outlook.

Euro Decline Amid Economic and Political Woes

The euro has experienced a significant decline, losing approximately 1.3% against the US dollar since Thursday's close. This marks the worst two-day loss for the euro in two months. The decline is attributed to a combination of economic and political factors. A hot US jobs report released on Friday suggests that the Federal Reserve will maintain higher interest rates for a longer period, while the European Central Bank (ECB) has recently eased its monetary policy. Additionally, French President Emmanuel Macron's decision to call a snap legislative election has amplified political risks. Marine Le Pen's National Rally party, which is leading in polls, has previously called for ditching the euro, adding to the uncertainty.

Euro-dollar one-week and one-month 25-delta risk reversals, which were already in favor of puts before the weekend's European vote, widened further on Monday. This indicates that traders are becoming increasingly bearish on the euro versus the dollar over the coming week and month. The path of least resistance appears to be for the euro to go lower, but the extent of the decline will largely depend on institutional investors. According to the latest CFTC data, institutional investors have boosted their bullish euro bets for a fifth straight week through June 4. However, the results of the election may deter them from adding to their positions.

Political Uncertainty and ECB Easing

The outcome of the European parliamentary elections over the weekend has made the prospect of another interest rate cut in the region even more distant. With French President Emmanuel Macron calling a snap legislative ballot, political uncertainty has been added to the euro, which will persist for at least a month during the election process. A weaker euro does not bode well for inflation in the eurozone, which has been ticking higher recently.

Austria's central bank governor, Robert Holzmann, expressed concerns about the recent weakness in the euro even before the election results. He noted that if the Federal Reserve is unable to implement three rate cuts this year as outlined in its dot plot, it would impact the exchange rate and inflation. With the eurozone's headline and core inflation both hovering closer to 3% than 2%, and the ECB conceding that price pressures will remain elevated through this year and next, the case for a second rate reduction anytime soon was already tenuous.

Friday's US jobs data, which showed payrolls expanding more than expected, should cause eurozone traders to further calibrate their views. The Fed may be hard-pressed to stick to its three reductions mantra for 2024 when it meets this week. If the Fed does less on the monetary front than it wants to, many on the ECB's governing council may balk at any decision that would widen the policy rate differential in favor of dollar-denominated assets.

Market Reactions to EU Election Fallout

The European stock market has also reacted negatively to the political developments. French stocks led a selloff in European equities, with the CAC 40 index down 2.1%. Bank stocks were the worst hit. The euro fell 0.5% against the US dollar, reaching a one-month low. The political uncertainty stemming from Macron's call for a legislative vote following a crushing defeat in the European Parliament election has contributed to the market's negative sentiment.

Debra Aho Williamson, an independent tech analyst, commented on the situation, stating, "The strong first-quarter guidance should take some of the AI pressure off Meta that we've seen with Google and Microsoft so far this week." However, she added, "Eventually investors will need to know more about when Meta is going to start generating revenue from AI."