EUR/USD - Are investors complacent about French election risk?

The EUR/USD pair is trading above 1.0714 handle this Friday morning in Asia after having faded spike to 1.0777 levels on the back of a broad based strength in the USD index.

Melenchon’s late surge

It appears that the markets are under appreciating the possibility of Le Pen or Melenchon winning the elections. As of now, as per the polls, Macron is tied with Le Pen with 22% support for the first round. Mélenchon has now bypassed embattled conservative François Fillon for third place.

Le Pen has promised EU referendum and has pledged to suspend immigration. With Melenchon, one may expect a more hardline stance on anti-EU measures and immigration.

However, markets look complacent. This is evident from the Franco-German 10-yr yield spread, which stabilized around 73 basis points over the last few days and narrowed to 61 basis points. EUR/USD too has recovered from the low of 1.0569 (Apr 10 low) in line with the stability/narrowing of the yield spread.

Options market says otherwise

The EUR/USD options market suggests the investors are hedging for a potential fall in the EUR. The risk reversals which measure the cost to investors of protecting against a sudden decline in the Euro fell to -4.3 earlier this week, the lowest level in more than five years.

EUR/USD Technical Levels

A break above 1.0777 (previous day’s high) would expose 1.0829 (Feb 2 high). A daily close above the same would add credence to the bullish RSI and open doors for 1.0873 (Dec 8 high). On the lower side, breach of support at 1.07 (5-DMA + psychological levels) would open up downside towards 1.0659 (10-DMA) and 1.0625 (support offered by the trend line drawn from Jan 3 low and Mar 2 low).