FX Trading Scenario Outcomes

We price the French (EUR/USD), the UK (GBP/USD) and the US (DXY) election probabilities.

Last month we covered the market impact of some emerging market elections for good reason - politics matters.

From the US Presidential election debate last night, to the first round of the French elections on Sunday, to the UK election next Thursday, our focus is on developed markets at the moment.

With these events, we wanted to lay out some scenario outcomes of what things could look like from a markets perspective. Writing from an FX background, I feel most comfortable expressing this via FX as an asset class.

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The French Election (EUR/USD Spot Ref 1.0696)

First we flag up how the major parties/coalitions are currently polling:

There are three main outcomes here:

1, Macron’s Centrist Ensemble party largest in hung Parliament, or outright majority

Both of these scenarios have a small probability, which we assign as 15% and 5% respectively.

Should either happen, we expect a relief rally in EUR/USD towards 1.0850 on being the largest party with a hung Parliament or 1.0900 on an outright majority. Hedges would be removed, which will likely contribute to the short-term spike.

In the medium term, the hung Parliament outcome depends on who joins forces, but effectively provides a stalemate of enacting new policies. Given this is against the backdrop of more radical policy implementation from the far left or right, a stalemate isn’t actually as bad as it might initially sound.

2, The far right RN are the largest party in a hung Parliament, or have a relative or absolute majority

This is the highest probability outcome. We see the cumulative outcome for the three potentials as being 45%.

In this case we see EUR/USD modestly moving lower depending on the size of victory. A relative majority probably takes us down to 1.0650, with an absolute majority down to the YTD lows at 1.0600.

Any form of combination with Ensemble would be seen as a steadying factor for traders, again due to the lack of ability to push through any major reforms in the initial phase of governing.

3, The far left coalition are the largest party in a hung Parliament, or have a relative or absolute majority

This likely the worst case scenario for the markets. We attached a 35% chance across the board of some variation of this happening.

An absolute majority could push EUR/USD down to 1.02-1.04, both on the surprise factor and the implications of what this could do to France. As just one example, the huge increase in spending and the expansion of the debt to GDP ratio from the far left would be damaging.

A relative majority or even being active in a hung Parliament would likely price us at 1.0500.

The UK Election (GBP/USD Spot Ref 1.2660)

1, Labour wins a landslide majority, or a majority

We see this as the base case outcome with an 80% probability. Even though the % figures above might not indicate such a high probability, the UK operates with a first past the post system, whereby each of the 650 constituencies elects one MP. The candidate with the most votes in each constituency wins. When you look and weigh this up, the amount of seats to get a majority looking overwhelmingly in Labour’s favour.

In terms of the market impact, we see little scope for a sharp move, given that this outcome has already been priced in and the scope of uncertainty is very low.

A majority likely pushes GBP/USD to 1.2700, but a super majority could take us down to 1.2600. Our thinking on this is that without any meaningful opposition to policies, the party could embark on increased unfunded spending commitments which could be damaging to public finances.

2, A hung Parliament

With the next three parties polling in the 15-18% range, a twist in the tail would over the next week would be all of these parties taking some share away from Labour, to potentially force a hung Parliament.

We give this a 15% outcome, with Labour still likely to be the largest party within this scenario. We feel this would be both a surprise and a negative for the UK in general, and would push GBP/USD down to YTD lows at 1.2300.

Given where the parties sit on a spectrum, a Labour/Tory or Labour/Reform pact would be impossible, so teaming up with the Lib Dems or Greens the most likely, but even that isn’t a great outcome.