The French Prime Minister recently faced a significant challenge after losing a confidence vote in the national assembly. This has sparked a search for a new Prime Minister. President Macron must find someone acceptable to the different political factions. If he can’t do this, a new election may be necessary. While this political uncertainty unfolds, Fitch will review France’s sovereign rating on Friday. Despite the turmoil, the euro remains stable, with the EUR/USD exchange rate around 1.1770.

Risk Assessment

With Fitch’s review coming up, we should expect some market fluctuations. The difference in yields between French 10-year government bonds and German Bunds is a key indicator and is already widening towards 75 basis points, a level we saw during the political stresses of 2024. This indicates that traders are preparing for higher risks before the decision is announced. Interestingly, the euro’s strength seems separate from the political risks in France, which is the second-largest economy in Europe. The implied volatility on one-month EUR/USD options remains low at about 6.2%, making it fairly easy to buy downside protection. It might be wise to purchase euro put options to guard against any negative surprises from the political situation or Fitch’s rating decision. It’s important to note that Fitch downgraded France’s rating to AA- in April 2023, citing high government debt and political gridlock as primary reasons. Since then, France’s debt-to-GDP ratio has struggled to stay below 110%, and the current political instability only heightens these fiscal concerns. Another downgrade or a negative outlook is very possible.

Market Strategies Amid Uncertainty

The market’s calmness might create an opportunity for a sudden rally if President Macron successfully appoints a market-friendly Prime Minister. Given the potential for either a sell-off or a rally, it makes sense to structure trades that can profit from a significant move in either direction, such as a long straddle on the CAC 40 index. This approach allows us to benefit from the uncertainty rather than guessing a specific outcome. Create your live VT Markets account and start trading now.

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