A confidence vote concerning French Prime Minister Bayrou is scheduled for later today, with results expected around 1500 GMT. The euro currency has largely ignored the potential risks involved, despite Bayrou being likely to be ousted. Societe Generale suggests that potential market reactions have not been fully considered.
Possible outcomes include Bayrou losing the vote, followed by the appointment of a caretaker prime minister, or the dissolution of the National Assembly. This would likely result in elections with a potential hung parliament outcome. If the elections lead to a hung parliament or a National Rally win, this may trigger political and fiscal risks. This scenario could negatively impact the euro.
Any positive outcomes from the situation could still result in limited and potentially negative impacts. Societe Generale indicates that markets are currently complacent, with the probability-weighted forecast for EUR/USD suggesting a target of 1.1570.
With the French confidence vote today, we see markets are shrugging this off, as one-month EUR/USD implied volatility sits at a calm 5.8%. This suggests traders are underestimating the potential for turmoil if Prime Minister Bayrou is ousted this afternoon. This complacency presents an opportunity, as the risk is skewed towards a negative surprise for the euro.
The most probable outcomes involve either a caretaker government or dissolving the National Assembly for a new election. We only need to look back to the snap election of summer 2024 to see how this can play out for markets. A new election brings the significant risk of another hung parliament or a National Rally victory, which recent polls show leading with 34% of the intended vote.
The spread between French and German 10-year bonds is a key indicator to watch in the coming weeks. While it’s currently around 65 basis points, we saw it blow out past 80 basis points during the political uncertainty last year, showing how quickly sentiment can turn. A similar spike would signal major stress and weigh heavily on the euro.
Given the low cost of options right now, buying some downside protection, like EUR/USD put options, could be a cheap way to position for turmoil. This strategy would profit from both a drop in the currency’s value and a potential spike in volatility. The current low volatility makes the entry price for such a trade attractive.
Even if Bayrou somehow survives, the upside for the euro appears very limited. On the other hand, the probability-weighted view points toward a potential drop to the 1.1570 area if political instability takes hold. The risk is clearly not symmetrical, favoring those positioned for a weaker euro.
