Forex and fixed income trading action during Thursday’s European morning suggested investors were becoming less wary about this weekend’s first round vote in the French presidential election.
The euro was advancing 0.5 per cent and had reclaimed the $1.0750 level, touching a three-week high in the process.
The German 10-year Bund, which many see as the prime haven asset to protect against eurozone angst, fell back in price, pushing yields back above 20 basis points. French government bonds were steady.
But Athanasios Vamvakidis, forex strategist at Bank of America Merrill Lynch, thinks the market is too sanguine because “almost anything is possible based on the polls”.
“The worst outcome for markets is if Le Pen and Mélenchon are in the second round, in our view, as markets could start pricing Frexit risks. Markets could also react negatively to a Fillon and Mélenchon second round, as the polls suggest Mélenchon could win.”
True, forex traders are hedging. The euro/US dollar “risk reversal”, which shows the extent by which investors are protecting themselves against a fall for the euro, has hit extremes.
“But markets are still underpricing the risks, in our view,” says Mr Vamvakidis.
“Investors remain long European assets and long EUR. We see asymmetric EUR risks from the elections, with EUR/USD at $1.10 in a positive scenario, but below parity and as low as $0.90 in a negative scenario.”