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Will the French election shake the euro?

Here are the main questions for markets and investors as new trading week begins.

What impact will the French presidential election’s first round have on the euro?
After months of polls and campaigning, show time beckons. For all the angst over political risk from analysts the euro is stronger by 1 per cent for the year, loitering around $1.06 to the dollar. Marc Chandler at Brown Brothers Harriman says traders have ‘’little enthusiasm to sell the euro below $1.06’’ as that level reflects a trend line drawn off the January and March lows.

Some argue that a better barometer of election risk is the euro versus the Japanese yen. In recent weeks, the euro has fallen 6 per cent from ¥122, and broken below ¥116. In turn, one-month implied volatility for the currency pair has shot up to its highest point since 2011, based on closing levels. A similar volatility measure for the euro versus the dollar has also climbed beyond last June’s closing peak when the UK voted to leave the EU.

The bond market also stands out as a barometer for political risk, with the relationship between 10-year French and German yields back above 70 basis points, a level not consistently seen since 2012.

Clearly, risk barometers are flashing, and plenty rides on French voters shying away from the extreme left and right of the political spectrum, with the market expecting Emmanuel Macron will ultimately prevail next month.

Such an outcome would only bolster sentiment towards the eurozone. Already we are seeing money increasingly shift towards Europe as some global investors rotate from expensively valued US shares. In turn that’s shapes as supporting the euro, with the political focus shifting towards Germany’s elections.

‘’The medium-term case for the euro to usurp the dollar as strongest of the major currencies grows steadily even if European political uncertainty holds it back in the short term,’’ says Kit Juckes at Société Générale.

North Korea — how much are markets worrying?
Look at traditional havens such as the yen and US Treasuries and investors appear concerned. Both reached fresh five-month peaks in Asia on Monday as US vice-president Mike Pence, visited the demilitarised zone and pledged support to South Korea at the start of a four-nation tour of the region.

The yen pushed the dollar back to Y108.15 and gains for US Treasuries pushed yields as low as 2.19 per cent. Gold has gained 3.3 per cent so far this month and is up nearly 8 per cent since mid-March.

Analysts have pointed out the irony — and the misplaced confidence — in the yen as a haven during times of tension surrounding its near-neighbour since one of the biggest threats is a missile strike by North Korea that could reach Japan.

And stocks in Tokyo and Seoul appear relatively unfazed as yet: benchmarks in both ended 0.5 per cent higher on Monday as the sabre-rattling continued.

The bigger question perhaps is how much markets should worry, and the answer is probably more than they are. But investors have always struggled to price geopolitical risk and this is no exception. Based on geography alone however, Treasuries would appear a better haven than the yen.

Can the Trump administration talk down the dollar?
A weak dollar and a stronger US economy does not compute. Improving economic activity entails further interest rate increases from the Federal Reserve, providing a tailwind for the dollar.

Last week President Trump sought to talk down the dollar, some four months after the currency registered its ‘reflation trade’ peak following the US presidential election. While Mr Trump’s remarks triggered selling of the dollar, the scale of the move was limited as the market has increasingly soured on prospects for the reflation trade. Perhaps, Mr Trump is rehearsing his lines on the dollar, as should he succeed in persuading Congress to pass tax cuts and other fiscal proposals in the coming months, a stronger dollar is a logical outcome.