French President Emmanuel Macron faces a tough reelection campaign. A victory for far-right candidate Marine Le Pen would crash the euro. EUR/USD is struggling, partly in due to a re-estimation of Le Pen's chances. A victory for Macron would boost the euro. Once bitten, twice shy – Investors are still licking the wounds from Brexit, Russia's invasion of Ukraine and other improbable events that became reality. A low-chance event carries big risks, and markets seem unwilling to take any – but with the French elections, they may have gone too far. Background France is the eurozone's second-largest economy, the only member with nuclear arms and after German Chancellor Angela Merkel's departure, the old continent's leading pro-integration force. Incumbent President Emmanuel Macron has been a champion of "more Europe" and a victory for his far-right rival Marine Le Pen – who supported "Frexit" in the past – would be a nightmare for the project. It would also devastate the euro. France's economy is over one-sixth for the full 27-member bloc: Source: Eurostat The young, energetic and well-educated leader at the Elysee Palace suffers from an image of being a president only for the rich, which is exacerbated by rising costs and plan to cut pensions. His rival has moderated her anti-immigration and anti-European stances, focusing on bread-and-butter issues and gaining more votes. The vote on April 24 will be the pair's second encounter. Back in 2017, mainstream parties and the public united behind Macron, leading to a 66% victory for the centrist that seemed to come from nowhere. This time, he is no longer the new guy, but rather the one overseeing the handling of covid, war, economy and many other issues – with some managed better than others. It is a referendum on the incumbent, and inherently pessimistic France may vote him out.  Nevertheless, despite the incumbent's woes and Le Pen's moderation, he still leads the polls. Her campaign materials included a picture with Russian President Vladimir Putin, and her condemnation of the war has a limited mitigating effect. Moreover, Macron's active campaigning has helped him shore up left-leaning voters, who prefer a capitalist that champions human rights over a populist who is tough on them.  As this "poll of the polls" shows, Macron is en route to win 54% of the vote, beating Le Pen by 8 points – and that gap is widening, not narrowing. The magazine gives him 87% chance of winning reelection.  Source: The Economist Three scenarios While a broad share of support for the far-right would provoke soul-searching in Europe, it would be enough for markets to stage a relief rally. As mentioned in the outset, investors are far from fully pricing in a return of the pro-market leader of one of Europe's most important countries.  1) Easy Macron win: In case Macron wins easily as described here, EUR/USD would rise, breaking one or perhaps two resistance lines if other factors also align. As results are due out on Sunday before markets open, the pair would open the new week with a gap, that would likely hold throughout Monday until other factors come along. High probability.  2) Tight race: If exit polls show a gap of less than 5% between both candidates, EUR/USD could open lower, perhaps losing one support line,  as investors would price the chance of Le Pen prevailing. The mix of uncertainty and low volume during the Asian session would trigger extreme volatility, shaking the common currency until the result is clear. Medium probability. 3) Le Pen win: If the far-right candidate ascends to the Elysee, it would be a major shock, no matter the market's cautious pricing. EUR/USD would tumble three or four support lines, and could drag down other currency pairs such as GBP/USD. Worsening French-British relations would weigh on both currencies. Such a scenario would likely play out only in the early hours of Monday rather than in exit polls on Sunday. Low probability.  Final Thoughts While a Le Pen presidency would have profound political and economical implications, the probability is low – similar to a Trump victory in 2020 rather than 2016 – and Macron will likely prevail. Five more years of economic liberalism in one of the Western world's more protective countries would be market-friendly and boost the euro. 

Outlook: The data today is housing starts and permits, never inspiring in FX. A couple of other things are holding attention. St. Louis Fed Bullard said the FOMC shouldn’t rule out rate increases of 75 basis points. This seems to be a generality and not a call to arms for 75 bp in May, but is still a shocker. Secondly, the dollar/yen has zoomed past the previous high (125.86 from June 2015) and is now at the highest since April 2002, literally 20 years ago. The all time high on our eSignal data base is 135.16 from December 2001. The much longer Reuters data base remind us that the dollar/yen was 250-300 during the 1980’s and broke below 200 around 1985. See the chart. Various Japanese officials, including FinMin Suzuki, have been muttering about a too-weak yen as destabilizing, etc., leading to some muted chatter about intervention. Overnight he said “the Japanese currency was weakening rapidly and indicated that the impact of the moves could be harmful for the economy,” according to Bloomberg. “We are monitoring moves in the foreign exchange market with a strong sense of vigilance.” Language that includes “watching carefully” is language that usually precedes intervention—but the day before, he had said “the market determines the FX rate.” Suzuki will join G7 and G20 in Washington tomorrow and will also hold separate meetings with the US. There is a hint that he may talk to TreasSec Yellen about the yen, a cousin to asking permission to intervene and perhaps inviting the US to join, but we doubt it. The last time we had coordinated intervention was when the yen crashed following Fukushima and before that, April 1998. But today what we have is not a crisis—it’s policy divergence. It would be a wild departure for Yellen to have anything to do (or say) about intervention when the solution to “the problem” is obvious. And is it really a problem? There is a small element of “don’t throw me in the briar batch, Br’er Fox.” After all, Japan has a trade deficit in goods, for which a weaker yen can only be good, even if it messes up corporate planning, as BoJ Gov Kuroda complains. Bloomberg credits the Bullard comments about 75 bp as the trigger for this latest runup, which may be true but not useful. The trend was formed when the Fed dropped “transitory” inflation and started loudly favoring big hikes and at the same time, Japan affirmed it’s sticking to curve control and intervened modestly to hold the 10-year JGB under 0.25%. We seldom see such a textbook-perfect case of policy divergence driving a currency. Bloomberg also says today is “the 13th day of yen falls against the dollar, the longest run of losses in Bloomberg data starting in 1971.” Again, perhaps true but definitely not useful. The most interesting thing of all is Fed Bullard speaking realistically about the neutral rate, which some point out implies a return of the Taylor Rule. The Taylor Rule got back-burnered during QE, but some adherents have been saying all along it’s the right idea that we should not be neglecting. Wikipedia has an excellent summary, by the way. More than one generation of economics students and countless Fed researchers have written about the Taylor Rule, which has multiple variations, including soft and hard versions. But the essence is that when inflation goes up by 1%, the Fed should raise the nominal interest rate by more than 1% in order to keep the real rate positive. Considering the number of hikes now contemplated for this year, we will end the year just under a positive real rate. And that’s assuming two hikes of 50 bp each and no increase in inflation. Bullard said the Fed should get rates to 3.5% by year-end and thence to a neutral rate of about 2.4% "expeditiously." And oh, yes, talk of recession is premature. The return of the Taylor Rule is a welcome development to reality-checkers and a headache for the Fed, which is going to have a devil of a time with QT. But Bullard is now the hero of the “sane and reasonable” crowd. If we assume Bullard is right—again—the US may be on the path to normalizing the vast divide between financial conditions and the real economy. It can’t possibly go smoothly but removing government interference in markets is generally a Good Thing from the point of view of properly determined prices. (It can be a bad thing from a fairness or humanitarian point of view.) So, while bond yields in other places are rising alongside the US but lacking this much clarity, notably the ECB, the US is the leader, so to speak, even if it was others who technically raised rates first. This can only benefit the dollar, if not...

EUR/USD - 1.0774 Euro's selloff from last Thursday's peak at 1.0923 to a near 2-year bottom at 1.0758 in post-ECB suggests medium term downtrend remains in force and as 1.0830 has capped subsequent recovery, yesterday's retreat to 1.0771 on broad-based usd's strength due to rally in U.S. yields suggests consolidation with downside bias remains, below 1.0758 would yield 1.0730/35. On the upside, only a daily close above 1.0834 signals a temporary trough is in place and risks stronger gain to 1.0860/70. Data to be released on Tuesday  New Zealand business NZ PSI, GDT price index, Japan industrial production, capacity utilization. Canada housing starts, U.S. housing starts, building permits and redbook.

If the current market phenomena were to star in a Shakespeare drama, they would be ideal candidates for the Three Witches. Can you guess who would play who? Have you ever heard of Shakespeare’s mythological characters, the Three Witches? They are depicted as prophets who represent evil, darkness, chaos, and conflict. If you look at the market today, you will find ideal candidates for these dark roles. However, while rising commodity prices and inflation have a casting win in their pocket, there is no certain actor to play the third witch. Would the recession stand a chance? No Easter eggs today – instead, here is a story that may provide food for thought. (Credit: Macbeth meets the three witches; scene from Shakespeare's 'Macbeth'. Wood engraving, 19th century. Wellcome Collection. Public Domain Mark). Let’s start by representing an economic cycle with its different phases: Global commodity prices – in particular energy prices – surged at a fast pace following the COVID crisis. Notably, as major central banks responded to the economic slowdown by printing money, rising levels of inflation were observed as a result of accommodating monetary policy combined with accelerating oil and gas demand. The context was tight supply and high volatility triggered by (geo-)political unrest around the world (crises, wars, etc.). In fact, those inflationary periods of surged prices (foremost, fuel prices are often those pulling the trigger) are usually followed by a sudden drop in consumer confidence and, therefore, a sudden fall in demand, which may lead to a recession phase. To predict those phases, some analysts tend to spot the inverted bond yield curves. In one of its articles, Investopedia explains The Impact of an Inverted Yield Curve as the following: “The term yield curve refers to the relationship between the short- and long-term interest rates of fixed-income securities issued by the U.S. Treasury. An inverted yield curve occurs when short-term interest rates exceed long-term rates. Under normal circumstances, the yield curve is not inverted since debt with longer maturities typically carry higher interest rates than nearer-term ones. From an economic perspective, an inverted yield curve is a noteworthy and uncommon event because it suggests that the near-term is riskier than the long term.” Now let’s have a look at the mystic US government yield curves over the past 30+ years: US 10 YR in Orange versus US 2 YR in Blue. US 30 YR in Red versus US 5 YR in Indigo. (Source: TradingView) The inversion of yield curves – typically with a two-year rate higher than the ten-year rate or even a five-year rate higher than the thirty-year rate – has occurred prior to each of the last US recessions. This phenomenon also briefly happened last week and lasted for almost two trading days. (Credits: Small Exchange, Inc. Newsletter Apr 11, 2022) As you can see, the above charts demonstrate that US treasury yield curve inversions may sometimes be followed by a sudden drop in equity prices. Alternatively, David Linton was also showing how big falls in bonds were preceding big falls in stocks in a recent tweet: (Source: Twitter) Okay, now let’s ask ourselves a few questions. Do you think that the Federal Reserve (Fed) will be able to tighten its monetary policy as planned? Will stocks collapse? Will this trigger a recession? If so, when? In what phase of the economic cycle do you think we are? 3, 4 or in between, maybe? The first speculative scenario Growth will continue for now, and so will demand... However, as soon as the Fed begins to tighten as planned, the S&P will plummet. So, the Fed will either be forced to stop to prevent a crashing stock market and falling risk sentiment from hitting growth, or just go ahead with tightening to keep inflation at bay and face the consequences. In the latter case, Powell loses his job... The second speculative scenario Following ongoing inflation, there could be a recession with a collapse in demand in about 6 months or so. On the energy side, despite the drop in demand, prices shouldn't drop too much as they might still be supported by limited supplies. Any ideas about a projected time horizon? Regarding the Fed, I don't believe much in rate hikes. If they do so, they will plunge off their looming debt cliff. Maybe the Fed could keep communicating about future hikes if the markets are crashing. However, if they do any actual hikes, I bet they would probably be tiny ones, just to show some signals, but in the end, the actual rates wouldn't be much changed. J. Powell seems to be pretty much stuck. (Source: Giphy) Anyway, it is a moment of truth for central banks. Let me know what you think in the comment section. That’s all, folks, for today. I hope...

Outlook: The calendar is skimpy this week with most of the interesting data coming from the housing market, although now that mortgage rates are over 5%, we have some extrapolating to do. Because of the holiday, which seems to be getting stronger every year–we didn’t get Good Friday off in banking in decades past–we may have missed really quite good US data last week. The Empire State manufacturing survey jumped to 24.6 in April from -11.8 when a mere 1% was forecast. March industrial output rose by 0.9%, double the forecast, and capacity utilization is at 78.3%, the highest since 2007. This bodes well for the PMI due Friday. And weirdly, the University of Michigan's preliminary April consumer confidence survey showed a rise when a drop was forecast. Trading Economics has this: “The University of Michigan consumer sentiment for the US unexpectedly jumped to 65.7 in April of 2022 from an eleven-year low of 59.4 in March, preliminary estimates showed. Figures also beat market forecasts of 59, with the expectations index surging by 18% to 64.1. “Perhaps the most surprising change was that consumers anticipated a year-ahead increase in gas prices of just 0.4 cents in April, completely reversing March's surge to 49.6 cents. The current conditions gauge also increased to 68.1 from 67.2. Meanwhile, inflation expectations were unchanged for both the year-ahead (5.4%) and the five-year outlook (3%). Nonetheless, the April survey offers only tentative evidence of small gains in sentiment, which is still too close to recession lows to be reassuring. There are still significant sources of economic uncertainty that could easily reverse the April gains, including the impact on the domestic economy from Putin's war, and the potential impact of new covid variants increased while the inflation outlook was steady.” We usually don’t pay much attention to the Michigan survey, in part because the number of participants is quite low (we couldn’t find the latest number, which tells you something right there). In years past it was something like 1500, pitifully small for an influential survey. The survey makers themselves are a bit biased, as shown by the translated remark that April gains can easily be reversed. The site itself has an addendum on the political party breakout of responses. We admit it’s possible the US consumer is capable of ignoring risk and uncertainty but it’s a little harder to grasp that inflation expectations are steady at 3% for the 5-year outlook. Everybody knows about the price of gas and food. Is it possible they believe the government/Fed will tame inflation? This is, by the way, consistent with the 5-year breakeven at 3.33% and the 10-year at 2.89% (from FRED as of April 14). And notice that nobody is trumpeting on the front page that the negative 2/10 yield curve reading (-0.05% on April 1) has reversed and as of late last Thursday, tit had risen to +0.36%. We will hear less take of “inevitable and imminent” recession this week. Okay, it may not last, but it’s a warning that extrapolating a couple of weeks of data out 12-36 months is ridiculous. A ray of light about Europe and potentially the euro: yesterday Italian PM Draghi gave an interview to a newspaper–his first since Feb 2021--saying Europe can reduce energy dependence on Russia quicker than previously estimated, according to Bloomberg. “Diversification is possible and feasible relatively quickly, shorter than we imagined just a month ago.” This is after Italy secured gas from Algeria. He said “We have gas in storage and will have new gas from other suppliers,” and it would help a lot if people just turned down the thermostat. “Europe continues to finance Russia by purchasing oil and gas, among other things, at a price that has no relation to historical values ​​and production costs.” Talking to Putin is a waste of time–it doesn’t work, as we see. This comes ahead of a showdown on payments for gas. Bloomberg points out “…there is an increasing risk that Putin’s demand for gas payments in rubles will lead to a de facto gas embargo in Europe as lawyers in the bloc draft a finding showing payments in the Russian currency would violate sanctions.” If we expect US data to be fairly resilient, as Friday’s PMI will show, and expect the Fed minutes on Wednesday to affirm the commitment to a 50 bp hike at the May meeting, US yields should continue to rise. Yield differentials do not always determine a currency’s fate and we have had periods where the correlation simply isn’t there, but it seems to be in effect these days. Japan remains committed to curve control and the ECB is wavering indecisively, so that leaves the Anglo countries to lead the way not only to higher rates but also the end of QE and an...

EUR/USD struggled to register any meaningful recovery and languished near the two-year low. Dovish ECB, the Ukraine crisis weighed on the euro and acted as a headwind amid a stronger USD. Bets for a more aggressive Fed policy tightening, elevated US bond yields underpinned the buck. The EUR/USD pair languished near the 1.0800 mark through the Asian session on Monday and remained well within the striking distance of the two-year low touched in reaction to a dovish European Central Bank decision last week. In fact, the ECB left its key policy rates unchanged and reaffirmed that rate hikes would only come sometime after the Asset Purchase Program (APP) is concluded in the third quarter. This disappointed some investors anticipating a more hawkish tilt amid the record-high inflation. Apart from this, growing worries about the potential economic fallout from the Ukraine crisis continued to act as a headwind for the shared currency. On the other hand, the US dollar stood tall near its highest level since April 2020 and continued drawing support from expectations for a faster policy tightening by the Fed. The bets were reaffirmed by comments from New York Fed President John Williams on Thursday, saying that a half-point rate rise next month was a very reasonable option. This was seen as a further sign that even more cautious policymakers are on board for bigger rate hikes at upcoming meetings. Apart from this, inflation fears exacerbated the recent rise in the US Treasury bond yields, which, along with a softer risk tone further underpinned the safe-haven buck. That said, relatively thin liquidity conditions on the back of a holiday in Europe held back traders from placing aggressive bets and might help limit deeper losses, at least for the time being. Nevertheless, the bias seems tilted firmly in favour of bearish traders and supports prospects for a further near-term depreciating move. In the absence of any major market-moving economic releases from the US, the US bond yields will play a key role in influencing the USD price dynamics. Traders will further take cues from developments surrounding the Russia-Ukraine saga and the broader market risk sentiment to grab some short-term opportunities. Technical outlook From a technical perspective, the post-ECB swing low, around the 1.0760-1.0755 region, now seems to act as a pivotal point. Some follow-through selling should pave the way for a fall towards the 1.0700 mark before spot prices eventually drop to the 2020 low, around the 1.0635 area. On the flip side, attempted recovery might now confront immediate resistance near the 1.0850 region. Any subsequent move up could attract fresh selling near the 1.0880-1.0885 zone and remain capped near the 1.0900 mark. The next relevant barrier is pegged near the 1.0935-1.0940 area, which if cleared decisively might prompt some near-term short-covering move.