Almost exactly two years to the month after France rejected a referendum on European Union Constitution, dealing a severe blow to the euro, France’s decision on its next president may have an impact on the single currency. This Sunday, socialist presidential hopeful Segolene Royal will challenge the rightist candidate Nicolas Sarkozy in the second round the presidential elections.
Sarkozy served as interior and finance minister in the outgoing rightist government and won the first round of elections with 31.2% over Royal’s 25.9%. Sarkozy is seen as an advocate of free markets, vowing to cut taxes, create more labor market flexibility and reduce the role of state intervention in private companies. He also favors abolishing the 35-hour week brought about by the last Socialist government and intends to increase the number of hours to improve personal incomes and overall growth.
Royal’s socialist–oriented agenda favors state intervention in many industries such as defense, aerospace and energy companies, while raising pension funds partially funded with taxes on stock market revenue. A victory by her would not only be a surprise (since she is trailing behind with 5% to 6% in opinion polls), but also weigh on the euro due to her socialist-friendly policies.
Both candidates have openly spoken in favor of weakening the euro and taking greater political control from the European Central Bank. Even the market-friendly Sarkozy complained about the strength of the euro, which he said strained French exports and further widened the nation’s trade deficit. But with Segolene Royal’s policies seen in favor of higher taxes and more state interventionism, the surprise effect of her victory would not only remove the center right incumbent government but also trigger a negative euro reaction.
Last night’s presidential debate between Royal and Sarkozy was deemed a draw by most political analysts, but an Internet poll showed 53% of the 900 people polled to have found Sarkozy more convincing than Royal’s 31%. But it is notable that centrist candidate Francois Bayrou, who placed third in the first election round and whose electpriare could trigger the 18% swing vote, said he would not vote for Sarkozy based on his performance in last night’s televised debate.
The notable aspect of the latest pullback in the EUR/USD is the lack of negative news from the Euro zone along with the first upside surprise in U.S. data in weeks. Tuesday’s stronger than expected U.S. manufacturing ISM showing a rise to 54.7 in April from 50.9 in March was initially shrugged by the dollar, as it was released at the same time as the Pending Sales Index. The index showed a 4.9% decline in March sales after barely growing in February, prompting a sell-off broad in U.S. equities and the U.S. dollar on concerns of prolonged weakness in U.S. housing. But equity bullishness quickly re-emerged after News Corp’s $5 billion bid for Dow Jones & Co, which triggered the a new wave of buying, typical of high profile merger announcements, and boosted all the major equity indices. Quite notable about the initial equity market sell-off was the shrugging of the three-point increase in the manufacturing ISM report, as traders were preoccupied with the decline in pending home sales. But markets went on about their record-breaking ways, pulling the dollar higher with them, at the expense of the low yielding yen.
But it is important to caution that the current strengthening in the dollar reflects a welcome improvement in one part of U.S. fundamentals, rather than any signs of weakness in Euro zone fundamentals. With net speculative euro longs versus the dollar reaching their third-consecutive weekly-record high at 111,282 contracts, euro bulls will require reasons for a retreat before the next push higher. Such reasons include Tuesday’s stronger than expected U.S. manufacturing ISM report, and possible upside surprises in the U.S. services ISM, due today, and Friday’s April U.S. payrolls.
Yet the principal source of euro weakness could come from Sunday’s French presidential election in the event that socialist candidate Segolene Royal wins over Rightist candidate Nicolas Sarkozy. A combination of an upside surprise in U.S. payrolls on Friday followed by a Royal victory could drive the euro towards the $1.34 figure, especially as markets would reduce the odds of a Fed easing later this year.
Ashraf Laidi
Chief FX Analyst
CMC Markets US
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New York, NY 10005
(212) 644-4220
a.laidi@cmcmarkets.com
