UBS House View Daily

Thought of the day

21.04 - Can the euro leave politics behind?

With contributions from Thomas Flury and Constantin Bolz

Political risk has cast a shadow over the euro. Over the past year, around 75% of the euro's moves versus the US dollar have been determined by the gap between French and German 10-year yields – which has become a gauge of worries over a populist victory in France's presidential race (See Chart of the Day). So as worries of a National Front triumph have increased, the euro has fallen. It has also led investors to give the euro less credit for the region's improving economic outlook.

With the first round of the French election on Sunday, could this change? The outcome of the vote will tell. At the UBS Chief Investment Office (CIO), we believe the single currency would suffer a short-term setback if anti-euro National Front leader Marine Le Pen does significantly better than expected. And the impact would be especially negative if the outcome produces a second-round faceoff between Le Pen and ultra-left rival Jean-Luc Mélenchon, whose policies also threaten to unravel European integration.

If as the polls suggest, however, pro-European Emmanuel Macron remains the front-runner for the presidency, the euro could start to put politics in the rear-view mirror. A contest between Macron and Republican François Fillon, an establishment pro-euro Republican, would enable markets to shift the focus to Eurozone economics.

Here the news is more uplifting for the euro. Economic momentum accelerated in April to the fastest pace in six years, according to the manufacturing and services purchasing managers' indices. While the Eurozone still lags the US recovery, the data may no longer warrant emergency levels of monetary stimulus. If political concerns fade, the European Central Bank will likely start to prepare the market for a gradual reduction of stimulus. At the CIO, we are overweight the euro versus the US dollar in our global tactical asset allocation.

Chart of the day

Can the euro leave politics behind

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