On April 22 of this yearFrance will go to the polls to select her next President. Although the field is crowed with 12 candidates, the French electoral process quickly winnows down the choice and then produces a second runoff election between the two topmost vote getters on May 6th of 2007. Amongst the 12 hopefuls only three candidates stand a realistic chance of moving up to the second round the Socialist Ms. Segolene Royal, the centrist Mr. Francois Bayrou and the center right choice, Mr. Nicolas Sarkozy. At present, Mr. Sarkozy enjoys a comfortable lead over his opponents and appears to be shoe-in for the second round of voting.
Free Market Sarkozy?
Typically, a free-market, center right candidate like Mr. Sarkozy would be welcomed by the FX market with open arms. But this beingFrance, the election has become a much more nuanced and problematic matter for currency traders around the world. The issue? Mr. Sarkozys very vocal dissatisfaction with the restrictive monetary policies of the ECB. On March 19th Mr. Sarkozy stated, Competition is such with globalization that we don't need to fight inflation like we fought inflation 30 years ago. I want the Europeans to be able to do with the Euro what the Americans do with the US Dollar, the Japanese with the Yen and the Chinese with the Yuan (i.e. use their powers to influence exchange rates). ?We are depriving ourselves of an instrument to create growth, provide jobs, for purely ideological reasons. Well, the Euro doesn't belong to Trichet?and I'm not the only one in Europe who thinks so.
According to Financial Times of London Mr. Sarkozy went on to say that if elected, he would propose a plan to fellow EU leaders forcing a change in monetary policy to stop the "deindustrialisation of Europe". Specifically, he said the ECB's strong euro policy was the overriding cause of woes threatening the survival of Airbus. Although most market analysts would agree that Airbus troubles were a function of their own management mistakes, Mr. Sarkozys words could resonate strongly with the French populace since Chinas recently announced plans for the creation of its own civil aviation industry could rival that of both Airbus and Boeing.
Contrast the change in Mr. Sarkozys outlook with that of his predecessor Jacques Chirac, a member of the same political party. Last November, the much more circumspect Mr. Chirac made similar objections but in a far milder manner. He stated, I am very respectful of the independence of the European Central Bank but I wish all the same that everyone would be able to give his views on the way in which European monetary policy is conducted. On the other hand, Mr. Sarkozys decidedly more interventionist attitude towards EZ monetary policy may begin to raise concern on dealing desks from Tokyo to London to New York if he continues to lead in the polls.
ECB Unwilling to Budge
For their part ECB officials have been dismissive of Mr. Sarkozys attacks with European Commission's President, Mr. Jose Manuel Barros flatly stating, I think that these criticisms are mostly unfair because with the euro..the very same euro German exports are doing very well... I think that the solution to the problems that exist is for government to do what they need to do to stimulate growth and to take good measures and not raise questions about the central bank... The Central Bank must be independent; we cannot give precise instructions to the central bank because that would undermine the credibility of the euor.
Politics vs. Economics
Mr. Sarkozys most recent statements could be dismissed as mere political posturing were it not for the fact that European fiscal officials do have the legal authority to shape exchange rate policy via treaty power. As FT puts it, this is a backdoor means to force a cut in interest rates. The question for the FX market is whether France can garner enough support amongst other EU members to actually put such a plan into effect.
This is of course not the first time that French political actions have had a material impact on the euro. In May of 2005, the French were the first to reject the EU constitution - an act that precipitated a 1000 point loss for the EURUSD over the next several months as markets started to question the very survival of the currency.
The euro is a unique experiment in the history of man. It is the first attempt at creating a currency without a country. In the Euro-zone, monetary and fiscal control is widely separated. Over the past decade the ECB has labored hard to assert its authority over the currency, creating slow but growing confidence in the instrument. The euro is now looked upon by the vast majority of market participants as a viable reserve alternative to the US dollar. Indeed many central banks from Eastern Europe to the monetary authorities of the Gulf Cooperation Council in the Middle East have all increased the proportion of euro reserves in their overall mix. Furthermore, the euro experiment has clearly shown the massive productivity gains generated by the single currency in the EZ market. Nowhere has this been better reflected than in the GDP statistics with EZ growth outpacing US growth for the past three consecutive quarters despite the unit trading at near record highs against the greenback
However, currencies are always political as well as economic assets and should Mr. Sarkozy decide to actually implement any of his criticisms of the EZ monetary policy, the euro may come under tremendous pressure as traders once again lose faith in the unit. At the very least Mr. Sarkozys complaints may sway the ECB to proceed with more caution forcing it to follow a less aggressive monetary policy than it would like.
All Eyes on Paris
The possible election of Mr. Sarkozy introduces an element of political instability into the FX markets that has been absent for several years. Looking at the past as a guide, one attractive trade idea that such a run of events may present is a EURGBP short. During the upheaval of 2005 the EURGBP pair declined 200 points in the weeks following the rejection of the EU Constitution and were it not for the unfortunate terrorist bombings in London in July of that year the pair may have seen further downside pressure. With the current batch of UK economic data unabashedly pound bullish, suggesting a possible rate hike by the BoE in April, traders may want to consider a short EURGBP as a play on the possible fallout of from the French elections. In either case as we approach the voting deadline in France the currency market will paying more and more attention to the developments in Paris.