EUR/USD Exchange Rate Faces Pressure from Election Outcomes

European Parliament Elections: Populist-Right Gains and Market Reactions

by Faruk Imamovic
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EUR/USD Exchange Rate Faces Pressure from Election Outcomes
© Getty Images/Matt Cardy

The recent European Parliament elections have proven to be a turning point in the political landscape of Europe. Just over three weeks ago, we warned that these elections deserved more attention due to the potential gains for the populist-right. Our prediction was prescient. The populist-right made significant strides in both France and Germany, leading to a substantial shift in the political dynamics of these countries. In France, the National Rally (NR) secured a large share of the vote, prompting President Emmanuel Macron to call for legislative elections on June 30. A decisive win for the NR could see them sharing power with Macron's minority government, potentially leading to a major political realignment in France.

The rise of the populist-right is not just a domestic issue for France but has broader implications for the European Union (EU) and the Eurozone. Traditionally, concerns about the populist-right gaining ground have been associated with a weakening of the euro (EUR) against the US dollar (USD). This historical trend is likely to continue, putting pressure on the EUR/USD exchange rate.

Market Reactions and Economic Implications

European stocks and the euro have both experienced declines, partly due to the unexpected outcomes of the European Parliament elections. The May employment report from the United States also played a role, as it revealed stronger-than-expected job growth despite a rise in the unemployment rate. This led to an increase in forward US interest rates, diverging from European Overnight Index Swap (OIS) forward rates, exacerbating the pressure on the EUR/USD.

The populist-right's gains in the European Parliament elections have introduced new risks concerning the political stability and unity of the EU. The National Rally's victory in France is particularly significant. Winning nearly 32% of the vote, the NR dealt a serious blow to President Macron's centrist coalition, Ensemble. In response, Macron dissolved the National Assembly and scheduled new parliamentary elections, further intensifying the political uncertainty.

Macron's decision to call for new elections appears to be driven by multiple factors. He may have sought to avoid a potential censure from the current National Assembly, re-energize his base, or even maneuver the NR into a position where they can be blamed for any future political or economic issues. Despite these strategic considerations, it remains highly likely that the NR will emerge as the dominant force in the forthcoming elections, although they are unlikely to achieve an outright majority.

President of France Emmanuel Macron
President of France Emmanuel Macron© Getty Images
 

Strategic Consequences

If the National Rally secures a significant portion of the National Assembly seats, they will play a crucial role in choosing the next Prime Minister. This shift could place the NR at the heart of French domestic policymaking. During the presidential elections in 2022 and 2017, the euro performed poorly in anticipation of a potential NR-led government, reflecting market fears about France's commitment to the EU. While the likelihood of France exiting the EU is now more remote, the NR's participation in government could still have profound implications for EU policy, particularly in areas such as market interventionism, protectionism, and support for Ukraine.

The broader economic implications of the NR's rise include potential adverse effects on the euro. These developments reaffirm our forecast that the EUR/USD exchange rate will drop to 1.05 and remain at that level in the second half of 2024.

Global Monetary Policy

The outlook for global monetary policy is also a critical factor influencing market sentiment. The upcoming Federal Reserve (Fed) and Bank of Japan (BoJ) policy meetings are particularly significant. The Fed's Federal Open Market Committee (FOMC) meeting, scheduled just after the release of the May Consumer Price Index (CPI), will be closely watched. Any changes in the Fed's communications or the Summary of Economic Projections (SEP), particularly the "dot plot" showing interest rate projections, could have a substantial impact on market expectations.

In March, the dot plot indicated a median expectation of three rate cuts by the end of the year. However, this is likely to change, with even a single shift in the centrist dot potentially raising the median forecast and reducing the expected rate cuts. A more hawkish stance from the Fed, especially if corroborated by the May CPI data, could drive US long-term yields higher and strengthen the USD.

The European Context

The potential divergence in monetary policy between the Fed and other central banks, such as the European Central Bank (ECB), Bank of Canada (BoC), Swiss National Bank (SNB), and Riksbank, which have been easing monetary policy, could highlight the Fed's relative hawkishness. This, in turn, could further favor the USD, particularly if the US inflation data do not show a significant decline.

The political upheaval in Europe, driven by the rise of the populist-right, combined with divergent monetary policies across major economies, is creating a complex and volatile environment for markets. The outcome of France's legislative elections and the responses of central banks around the world will be critical in shaping the economic landscape in the coming months.

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