So, now that we’ve had an opportunity to take stock of what happened in continental Europe over the weekend, in order to overlay political rhetoric on the markets, rookie forex traders and top forex brokers alike would do well – in any event – to exercise a very large degree of skeptical restraint. As one of the wisest readers of the markets I know of, Simon Denham (pictured), CEO of Capital Spreads, is emphatic in reminding us all to try and avoid extrapolating what politicians say when they are trying to get elected from what they actually do!

“Monsieur Hollande is very unlikely to implement some of the more aggressive statements in his manifesto,” opines Denham. “Taxing people 75 percent above €1m euro would impact tax revenue and employment numbers very negatively. People should be aware that the bulk of big earners are not in financial services. They are in the vast array of private companies that proliferate across the European landscape,” concludes Denham. “Taxing the earnings of such people would drive investment out of France into more accommodative countries across the globe. The basic question you have to ask is ‘why would anyone invest, work, risk capital or time, only for the state to take the vast bulk?’”

In rejecting the tough austerity measures needed to get the euro zone off the ropes, regardless of what growth strategy can be conjured up, let alone actually implemented, the alternative of implementing some kind of Expansionary Austerity certainly would set markets on edge. Soft Austerity, as Denham says, “is just another way of saying ‘do nothing and hope something turns up.’  I am afraid that the woes of the euro zone sovereign debt situation are well beyond this.” 

One of the key concerns on which Denham touches is that government expenditure seems to be a virtually un-slayable beast. Companies appear able to actually cut or at least stop expenditure in not just ‘real terms’ but in actuality. But a huge swathe of government outlay (benefits/pensions/capital expenditure) is fixed versus inflation or other factors.  Therefore, to impact outlay would mean a combination of actually cutting salaries and final pensions (even those of people already retired), “slaying the dragon that has become the health budgets and maybe deciding that we don’t need to involve Europe in solving the World’s problems,” as Denham puts it. This said we all know that politicians will continue to make the easy choices until the choice is effectively taken away from them (Greece, Spain, Italy and Ireland), and Hollande risks falling into this camp.

As we see, today has given rise to a bit of a pull-back in markets. The major European markets are still up nicely on the year, while on the currency markets, the euro is starting to fracture a little at the edges while the fear remains that a break-up of the periphery might actually increase the value of the euro as the weight of Germany would no longer be counteracted by the weaker members.  For the last few years the effective range has been 1.20-1.46 versus the greenback, so meandering around 1.30 and 1.35, as it has done for the last four months, puts us pretty much in the middle of the game.

Whether or not eurodollar falls below 1.30, Kathleen brooks, Research Director at FOREX.com, sees a sustained break of 1.30 still possible. However, “In our view,” says Brooks, “the problem is the US. If the US was producing 200k+ jobs per month then EURUSD could be testing the 1.26 lows from January. But because the US only created 115k jobs in April, the prospect of more QE remains firmly on the table.”

Other euro crosses are also being kept high by pockets of weakness in the Aussie and the Kiwi. This leaves EURGBP and EURCAD as two potential crosses that could come under more downward pressure. As Brooks reminds us: “EURGBP has had a nice downtrend, and a test of 0.8000 looks likely in view, however this pair is already at a multi-year low so expect it to meander lower rather than fall through the floor.”

For a concluding thought, Neal Kimberley, FX analyst at Thomson Reuters, reminds me of an op-ed penned by Mitt Romney back in 2008. “It was entitled: Let Detroit Go Bust,” says Kimberley. "If you are looking for a bumper sticker to sum up how President Obama has handled what we inherited, it’s pretty simple: Osama bin Laden is dead and General Motors is alive," VP Biden recently said.”

The point, insists Kimberley, is that in the USA the political argument was whether to bail out GM or not. “In US eyes, the argument in Europe about Greece (and others) was not whether to bail them out or not, but what were the terms of the bail out. So, if you look at this weekend's elections through US eyes, you might well be excused for being a bit negative. To US investors, it probably looks as if some euro zone politicians (whether Greek or even Messier Hollande) are looking to welch on the terms of the bail-out deal and the recent fiscal pact.”

The question, therefore, that may again become important is, are US money market funds more or less likely to lend money to even the "best" euro zone names in this situation? Kimberley, for one, reckons the answer is less. “And that is ultimately why the euro may have to grind lower,” he suggests.

Drew Hillier. Editor