EUR: Faced with ‘Frexit’ risks – Goldman Sachs

Analysts at Goldman Sachs explain that since the beginning of the year, news around the French elections has driven the Euro as polls turned more favourable to Ms. Le Pen or, more recently, became less indicative of a possible victory for one of the two mainstream candidates (Mr. Macron or Mr. Fillon).

Key Quotes

“The market focus is now on the risk that France could leave the Euro area if Ms. Le Pen becomes the next President of France. However, given the uncertainty around the outcomes of the first and second round votes, and considering that a ‘Frexit’ would be a tall order even under a Le Pen presidency (see here), it is useful to assess how much the Euro could depreciate or appreciate under different scenarios.”

“An increase in the probability that investors assign to a break-up of the Euro area which is close to its peak in July 2012 could push the EUR about 5% lower versus the USD and the JPY, effectively taking EUR/USD close to parity. Conversely, should Ms. Le Pen fail to make it to the second round, EUR/USD could trade around 1.13 (from the current level of 1.0770).”

“The potential upside following a market friendly outcome of the French election would likely be much smaller given the market’s benign pricing of Euro area break-up risk currently, and given little evidence that we are in a ‘flight to safety’ regime, which would be the case should Ms. Le Pen win the French elections. That said, how negative and persistent the market reaction will be also depends on the policy response, which, however, is unlikely to be as straightforward as in the aftermath of the Brexit vote, when the ECB supported Italian and Spanish spreads by buying more sovereign bonds. This time, the political constraints posed by France leaving the Euro area could also constrain the ECB, as some members of the Monetary Union will likely be concerned about Target 2 imbalances in a scenario in which a break-up of the Euro area becomes a realistic threat.”