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April 16, 2012

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Elections in France and Greece could spell trouble for the euro


Elections in France and Greece in less than a month΄s time could spell trouble for the euro and for euro-zone sovereign bonds but, if markets are worried, they aren΄t showing it so far.

According to Dow Jones Newswires, whether that smacks of complacency remains unclear, market participants say. Euro-zone worries have resurfaced regardless in recent weeks because of fresh doubts over Spain΄s capacity to rein in its finances.

But for now, financial fear gauges show investors aren΄t losing much sleep over the elections, which on paper could yet scupper the euro zone΄s current grand plan to escape its debt crisis and as a result hurt the single currency.

In foreign-exchange derivative markets, the cost of buying protection against a slide in the euro against the dollar in the next month remains near the multi-year lows seen in late March. Option bets on the euro falling rather than rising against the pound over the same period also aren΄t commanding a premium.

Meanwhile, the extra interest demanded on 10-year French government bonds over and above similarly dated super-safe German bonds has risen to levels last seen in January as Spanish fiscal worries have resurfaced.

But at around 1.3%, that΄s still some way short of the 1.9% or so seen late last year and has been driven more by the strong performance of German bunds rather than election worries driving up the premium demanded for holding French bonds.

Helping to explain the relatively muted market response to date is the widely held belief that both Greece and France have very little room for maneuver, whichever way the French and Greeks vote.

"Any politicians that get elected will have to bow to economic realities. There is a very narrow degree of freedom in what politicians can do without creating troubles in the market," said Munich-based Thomas Kressin, who heads foreign-exchange operations in Europe for Pacific Investment Management Co., or PIMCO, the world΄s biggest bond-fund manager.

But for Simon Derrick, a senior currency strategist at BNY Mellon in London, traders haven΄t yet started thinking about the French presidential and Greek parliamentary elections after a tumultuous few months worrying about default-threatened Greece΄s debt restructuring and second bailout.

"There was so much thrown at us in the first quarter that people have not had the opportunity to look ahead," said Derrick.

That could change as the elections approach, strategists say.

In France, the first-round presidential vote is Apr. 22, with a second-round runoff between the top two candidates on May 6 if no candidate wins an outright majority the first time around. Barring an upset, that should see the incumbent Nicolas Sarkozy battling it out with the Socialist Party΄s Francois Hollande.

May 6 is also the most likely polling day for Greece, especially since Greece is expected the dissolve parliament Wednesday but no official date has yet been set.

The risk here is of a fractured result that leads to a multiparty government including smaller, more extremist parties which, unlike the bigger parties, haven΄t given written commitments to carry out key reforms and put Greece΄s finances on a more sustainable footing. That could jeopardize Greece΄s bailout funds and bring the specter of a default back into sharp focus.

"The lack of strong government does not bode well for decisive action or painful structural reforms," warned Marc Chandler, chief currency strategist at Brown Brothers Harriman.

Then there΄s France, where the front runner Hollande has pledged to renegotiate the treaty crafted by European leaders in January to tighten up the region΄s debt and budgetary rules. This fiscal compact agreed by 25 European Union governments is crucial to regional efforts to win back investor favor.

"Markets should, in our view, be particularly concerned about a possible reopening of the fiscal compact," said Alastair Newton, senior political analyst at Nomura.

In recent weeks Hollande΄s lead has looked shaky. An Ipsos poll published Monday showed Sarkozy narrowly ahead of Hollande in the first round. But that poll still showed Hollande comfortably winning a second round with 55% of the vote.

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