Concerns surrounding the European elections are heightening, with the Australian dollar soaring close to a four-year high against the euro on Thursday as investors fret about the possibility of Marine Le Pen winning the French election .
Despite particularly encouraging data out of Europe – eurozone private sector and manufacturing growth unexpectedly accelerated near a six-year high this month and job creation was at its fastest pace since August 2007 – investors are nervously contemplating "redenomination risk" and positioning themselves accordingly.
This week, investors snapped up short-dated German bonds, forcing yields down to record lows of 0.9 per cent (yields move inversely to prices), and are demanding a high premiums to hold French bonds, widening the spread.
Redenomination is the process of changing the face value of banknotes or coins used in circulating currency, and in the short term, that risk is coming out of France.
Far-right presidential candidate Marine Le Pen has vowed to remove the country from the euro if she wins the election in May. If she succeeds, France's €2 trillion national debt would need to be redenominated into a new currency, presumably the franc.
"It all seems to be linked with the French political woes," said Patrick O'Donnell, an investor at Aberdeen Asset Management.
"The [German] front end (sort-dated bonds) is the safest place to be," he added. "If redenomination risk were to reappear, then the short-dated maturities of France and Spain would be the ones that would come under pressure."
It appears political risk is again smothering economic data. The eurozone has posted 14 consecutive quarters of growth and a measure of economic sentiment is at its highest level in six years. Despite this, the gap between German bunds (seen as the safest asset in Europe) and French bonds has continued to widen.
Equity markets on the other hand have raced away higher, with Wall Street consistently clocking up record highs and European shares also remaining buoyant.
Recent polls show a growing support for Le Pen's National Front party and many argue it is this that is causing the euro to sink and forcing Dutch two-year yields to also hit record lows. Betting markets ascribe a 43 per cent probability she will take the presidency.
On the other hand, French two-year yields are remaining lifted at
Investors are particularly nervous ahead of the French election, given the shock outcomes of the British referendum to leave the European Union and the election of Donald Trump to the White House in the US.
"Investors are bracing themselves for more surprise outcomes," said Willem Buiter, chief economist at Citigroup.
"But while we place a higher probability on a Le Pen victory than before the Brexit and Trump results, and note that some erstwhile FN voters may take courage from fellow anti-establishment voters in the UK and US, we caution that assuming that France will be 'next' is overly simplistic."