Euro likely to muddle through barring a Mélenchon/Le Pen scenario

How big of a risk is the French election for the markets?

Frankly, quite a significant risk. Granted, it still seems likely that Macron will pull through as the compromise candidate, but I'd feel a lot better about the situation, from a market perspective, had Mélenchon not been steadily rising in the polls. Should the contest come down to a Hard Left versus Hard Right contest, with both candidates economically nationalist, and threatening much of the trade stability of the European Union, it's hard to decide who would be more economically troublesome. Le Pen is obviously the candidate one would least like to win from a moral standpoint, but whilst Mélenchon's heart may seem to be in the right place, his high tax regime would hit investors hard, be tremendously damaging to the French economy in its current form, and certainly destabilise important institutions from the Euro to the European Union itself. This is, of course, the nightmare scenario, and in all probability, Mélenchon's rise is a phantom bump, supported by those least likely to vote. Outside this possibility, it seems likely that Le Pen will face off against Macron, and polls, though less than accurate in recent times, do support a strong Macron victory. In the event of a Macron candidacy, European markets ought to expect quite a bump, with trouble finally off the short term horizon. Of course, if Le Pen were to win, all bets are off, and there is significant contagion risk for the markets. 

Which is the best tool to track French-election market risk? French bonds? CAC-40? Polls?

Personally speaking, I'd look to the polls, but also keep an eye both on the bond markets, and Euro currency pairs, in particular, pairs where the other currency is less exposed to risk, so that means steering clear of EURGBP, for instance, owing to Britain's own difficulties. British political ructions mean watching EURGBP is a measure of far more than the French Election. 

Polls are forecasting a very tight race among the main four candidates in Sunday’s first round: how low could EURUSD go in case of a Le Pen vs Mélenchon showdown in the second round?

I'd expect it to plummet, at least to parity, if not potentially below. In this scenario, however, should Mélenchon or Le Pen show signs of softening their anti-market stance, there could be an opportunity to buy.

And how high could the EURUSD rally if Fillon vs Macron was the outcome of the first round?

I wouldn't expect markets to stage a significantly durable rally, but you might see levels up to 1.09 or 1.10, though that would not reflect current market fundamentals and would represent an ideal time to sell. Essentially what Fillon and Macron offer is more of the same, with a slightly more market-friendly approach. The proof, so to speak, would be in the pudding, and with the proverbial French oil tanker notoriously difficult to turn, too much optimism would be a false sentiment. 

Could the French election have a GBP-Brexit-type effect on the EUR?

Absolutely, in the nightmare Le Pen-Mélenchon scenario. Otherwise, unless the compromise candidate were to be defeated in the second round, which is unlikely, I would imagine the Euro will do what it always does: muddle through.

Should traders prepare for important gaps in the Euro on the post-election Monday openings?

Certainly, regardless of the outcome, with so much riding on this election, not only in terms of the short-term financially, but also in the long-term spirit of the European market, volatility will be the order of the day until the outcome is clear. Attention should also be paid to the legislative elections in June, given that they too will help to set the tone.

Where would capital fly in case of a EUR meltdown if there was a Frexit? German bonds? USD? Other currencies?

The likelihood is that a lot of investors would look to dollars and gold. German government bonds would certainly be a good bet, as would those of larger German companies with strong exposure to their own domestic market. What would be very interesting to see in such circumstances is how and to what degree the European Union would remain cobbled together. German sentiment seems broadly in favour of European Institutions, and should the doomsday scenario happen, it would be likely that a Northern European Union of sorts would come together. This would mean there would be some extremely interesting investment opportunities, with Scandinavian bonds, or those of the Low Countries, or even riskier bets, like Ireland, potentially seeing strong boosts from being in a much stronger currency union. JPY could also be a currency to watch in the case of a Frexit.

Is the European Union "two-speeds" idea good for the EUR in the long-term?

As a European citizen myself, my personal and political view is no, simply based on the fact that I think it betrays the essential principle of the European Union, which we all signed up for. That said, from a financial point of view, I think it absolutely is. The Euro, while a nice idea on paper, has the problem of being a currency union, without fiscal union, and without the will amongst European populations for the kind of population transfer, or redistributive economic system that could potentially make it work in its current form. A Southern and Northern Euro would actually be extremely beneficial for Southern European countries, given that it would in an instant make their exports significantly more competitive, and force the governments to live absolutely within their means, no longer able to rely on German strength keeping yields low. For the northern countries, the benefits are less evident, at present Germany sells its products at a significant discount, and whilst negative for the European Union as a whole, this is excellent for German manufacturers. So, from a macroeconomic and globalist point of view, yes a two speed Euro is an excellent idea. 

In terms of a two-speed Europe, in general, I think there is definitely a case for it, since some countries simply have more political interest in ever closer union than others. What needs to be born in mind here, is that this question really depends on the hodge-podge of historic ties in a continent that has a long memory and has more often than not been at war with itself. My own country, Ireland, is for instance quite fond of the ever closer union concept, not particularly in order to relinquish sovereignty, but because of two reasons. One, Ireland recognizes that as a very small country, it will always have to compromise, and that sovereignty in an interconnected market is many times just a chimera, and there is no appetite to go back to the 1930s Sinn Fein attitude, which loosely translates as ourselves alone. Secondly, there is a historic fear of our larger neighbour to the east, thus keeping the country tied to a larger power is quite the popular approach. Other countries, however have different historical biases. The Polish might not very well be too keen on an eventual unification with the Germans, or in the event of greater enlargement, the Croats with the Serbs. So, politics and history, in this case really do matter more than market sentiment, at least in the historic medium term. This being the case, a two-speed Europe has some excellent grounds for coming into existence. It would, however, be very important to ensure that potential fragmentation was kept in check.