The unexpected shock wave from the European parliamentary elections is still rippling through financial markets. The impact and aftermath of the vote have been magnified due to the absence of other significant market-moving data at the weekly open on Monday. Rising risk premiums, driven by political uncertainty being factored into European assets, have pushed the French 10-year government bond yield to its highest level this year and sent the euro to a one-month low. Short-term implied FX volatility increased slightly, reflecting the scheduled snap election in France at the end of the month. Option traders turned bearish on the euro at the fastest rate in 14 months. While the election has clearly influenced the market, its impact is more pronounced on a regional level than across Europe as a whole. This is evident in the price action: the EUR/USD fell more on Friday following the US non-farm payrolls report (-0.83%) than it did after the election results (-0.58%).
We believe markets have adjusted well to the new composition of the European Parliament. With the initial re-pricing process complete, the medium-term implications for the euro are likely to be more subdued, as the Federal Reserve and US macroeconomic conditions continue to steer the currency's direction. The risk premium due to the upcoming French election could limit significant gains for the euro. Additionally, US election risks will begin to attract attention, meaning political issues will remain a key focus for markets. Political uncertainty, the dollar, and volatility tend to rise in the lead-up to a US presidential election. However, US macroeconomic factors will continue to be the main drivers of price action. If the US economy slows more than expected and the Fed is forced to cut interest rates sooner than anticipated, European political developments will take a backseat to US events.
Christine Lagarde was the first significant central banker to comment on monetary policy following the European Central Bank's interest rate cut last Thursday, the first since 2019. Although the easing was justified by the disinflation observed over the past year or so, rates are not on a steady downward trajectory. She is one of several central bankers scheduled to speak this week. Additionally, the Eurozone will see the release of industrial production, Sentix investor sentiment, and trade balance data.
