Political risk returns as driver of forex trading

Political risk, the market phenomenon of 2016, showed signs of a return on Tuesday, knocking the euro back on investor concerns about the French presidential elections.

Worries about political issues also weighed on sterling because of renewed Brexit anxiety and sent the Turkish lira lower following another broadside from President Erdogan on interest rate policy.

The euro’s reaction to political risk reflected tension in the bond market where the risk of holding French debt has increased the yield gap over German Bunds.

At one stage, the dollar rose 0.9 per cent on the euro and was stronger across the board as investors sought haven assets against an uncertain political climate.

The market has become unsettled by the waning fortunes of centre-right candidate François Fillon and the potential benefit for far-right opponent Marine Le Pen.

Also causing anxiety are polls for this year’s German elections, which show increased support for SPD candidate Martin Schulz against chancellor Angela Merkel.

“European political risk is back on the agenda,” said Paul Lambert, currency manager at Insight Investments.

“That comes more from the trauma of having got Brexit and Trump wrong rather than a particular shift in the facts. The market is paranoid about getting the French elections wrong even though it appears extremely unlikely that Marine Le Pen can win.”

Marc Chandler at Brown Brothers Harriman said forex moves were not just about the euro but a sign of momentum returning to the dollar, which has been in retreat over investor doubts about President Trump delivering an inflation-generating economic policy.

Noting widespread dollar strength, Mr Chandler said: “We believe this is a return to the underlying trend after an extended correction.”

The pound fell back as parliament began to debate the government’s Brexit bill, slipping below the $1.24 mark.

Silvia Ardagna, Goldman Sachs forex strategist, said while the benefits of a weaker pound were starting to appear, there was evidence of foreign direct investment moderating.

“Sterling has to depreciate more” if a weak currency is to make it attractive for long-term investment in UK fixed assets, she said.

The lira slid 1.5 per cent against the dollar after Turkey’s president once again used an economic summit to criticise the country’s central bank. He described interest rate policy as “a means of exploitation”.

Ugo Lancioni, forex and fixed income portfolio manager at Neuberger Berman, said there were “too many moving parts” in the market — including European political risk and uncertainty about the Trump presidency — to determine a consistent trading theme.

“The market is very short-term in nature these days. The time horizon [for establishing a clear trade] is after the presidential elections in Europe,” said Mr Lancioni.