FX Daily: Limited Market Fallout from French Political Uncertainty and Fed Communications
By Chris Turner | Original Source: ING Think
Despite recent political unrest in France and shifts in the Federal Reserve’s narrative, foreign exchange (FX) markets have shown relatively muted reactions. The week started with political developments in Europe following the European Parliament elections, while remarks from the Federal Reserve added some uncertainty regarding its monetary policy path. Yet markets have not displayed the level of volatility typically associated with such events. This analysis breaks down recent events in the US and France, evaluates their limited impact on FX markets, and highlights potential market movements in the days ahead.
Key Highlights:
– Political instability in France following the European elections has led to increased sovereign bond spreads but not major FX market disruption.
– The Federal Reserve signaled a slower pace of monetary easing than anticipated, yet interest rate expectations remain relatively anchored.
– The euro has shown resilience despite these political and financial developments.
– The US dollar remains firm against most majors, with a few notable exceptions.
– Market participants appear to be waiting for further clarity on both fronts before making any significant moves.
French Political Risk: A Contained Reaction
Last week’s European Parliament elections proved momentous for France. President Emmanuel Macron’s centrist party faced heavy losses to the far-right National Rally (RN), prompting Macron to dissolve the National Assembly and call for early elections set to begin on June 30. This unexpected political move initially rattled markets, particularly sovereign debt and equity markets in France. However, the reaction in FX markets was more measured.
Effects on French Sovereign Bonds:
– French 10-year bond yield spreads over German bunds widened significantly, reflecting increased investor concern over political instability and fiscal discipline under a potential RN-led government.
– The OAT-Bund spread, which measures the risk premium on French debt, shot up by 25 basis points in one of the sharpest moves in recent years.
Impact on the Euro:
– Despite the widening bond spreads, the euro remained relatively stable, demonstrating resilience in the face of political noise.
– EUR/USD dropped modestly below the 1.07 level after the news but has since stabilized around that threshold.
– The muted FX market response likely reflects investor anticipation that the upcoming French elections will not fundamentally disrupt European Union fiscal or monetary cohesion.
Key Considerations:
– France’s political outlook remains fluid, with potential coalition alignments still uncertain.
– Markets may be waiting for further developments before increasing EUR-related risk premiums more significantly.
Federal Reserve: Confusing Markets with Cautious Messaging
The Federal Reserve delivered its June monetary policy decision last week, opting to keep rates steady while signaling only one possible rate cut for 2024. This was a deviation from the prior projection of multiple cuts for the year, leading to a market reassessment of the outlook.
Summary of Fed Messages:
– The Fed maintained interest rates at 5.25–5.50% as widely expected.
– Updated “dot plot” projections indicated only one rate cut in 2024 versus three previously expected.
– Fed Chair Jerome Powell adopted a carefully balanced tone, acknowledging recent progress in inflation data but signaling the need for more evidence before initiating rate easing.
Market Reactions:
– US Treasury yields rose modestly after the Fed’s announcement, reflecting reduced expectations of near-term policy easing.
– The US dollar gained across several currency pairs following the hawkish tilt in projections.
– However, stronger-than-expected inflation data for May helped offset some hawkish sentiment, adding to market confusion.
Investor Takeaways:
– Markets are currently pricing in 43 basis points of Fed rate cuts by the end of 2024.
– BI-annual testimony from Jerome Powell and monthly inflation data will significantly influence expectations going forward.
– The Fed’s cautious but open-ended messaging has left investors hesitant about strong directional wagers in the USD or Treasuries.
Eurozone CPI and ECB Dynamics
While headline inflation data across the eurozone remained firm, underlying inflation trends continue to
Read more on EUR/USD trading.