Euro Hedging Costs Climb on Le Pen Risk in French Elections

(Bloomberg) --

The cost of hedging the euro is rising as traders turn their focus to polls showing a closer race in the French presidential elections.

Options that protect against a drop in the common currency over the next week have risen to the highest level since March 22, ahead of the first round of the French vote on Sunday. Institutional investors and hedge funds have added exposure to a fall in the euro, traders said.

Polls show that French President Emmanuel Macron will win the first round to face nationalist leader Marine Le Pen in the second round two weeks later. Yet while he's likely to beat her by 53% to 47% in a runoff, that's a much narrower lead compared with the 60% to 40% gap seen a month ago.

Demand for exposure to low-probability outcomes, as shown by so-called butterflies, has also picked up since one-month options now cover the second round as well.

Options structures in demand on over-the-counter trades look for a move in the euro toward March lows around $1.08, but not much below, according to traders familiar with the transactions who asked not to be named because they aren't authorized to speak publicly.

The common currency has already dropped by 2% since its March 31 high at $1.1185, as quarter-end flows that were negative for the dollar are no longer a factor in the market.

Trader focus is also looking ahead to the next Federal Reserve decision in early May. Implied volatility for the euro-dollar pair on the one-month tenor, which now captures the meeting, is trading at its highest level in two weeks.

NOTE: Vassilis Karamanis is an FX and rates strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice