Beware The German “Hump”

Beware The German “Hump”

I’ve talked tirelessly (well, I haven’t gotten tired of it, maybe you have) about the extent to which markets are or aren’t correctly pricing event risk around Europe’s trio of electoral trials by fire.

For obvious reasons, the French elections have gotten the most attention. That’s probably justified given the fact that there’s a non-negligible chance that France accidentally elects a populist lunatic with designs on taking her country out of the EMU, a move that would i) effectively mark the beginning of the end for the currency bloc, and ii) may mark the beginning of the (financial) end for France which, if it exited the euro would technically be in default on…oh, I don’t know.. let’s just call it f*cking $1.7 trillion in public debt.

This month, the market will be watching the Dutch elections closely to see how successful crazy ass Geert Wilders is at marshalling the uneducated vote in the Netherlands (more on that here). “Elections in the Netherlands will set the tone for ballots in France and in Germany this year that will determine whether the voter anger that prompted the U.K.’s Brexit vote and brought Donald Trump to the White House is reverberating across mainland Europe,” Bloomberg wrote on Sunday, adding that “Wilders, who wants to stop all Muslim immigration to the Netherlands, has praised Trump’s agenda.”

The German elections have garnered less attention of late because… well, because they’re further away, for one thing. And while we’re exceedingly unlikely to see some kind of Petry-inspired Reich redux, it’s worth looking to see how the market is pricing things.

As regular readers will recall, I’ve focused primarily on the VSTOXX term structure and the juxtaposition with implied vol in the US. More recently, I took a look at vol spreads, their relationship with OAT-bund spreads, and how they look now versus how they looked in the lead up to the Brexit referendum.

Well for those interested, below find a few visuals and some color from SocGen regarding the prospect of getting out ahead of the German elections.

Via SocGen

The need to differentiate “risk” from “uncertainty.” Events that increase overall caution in financial markets often manifest themselves through increased risk premia and higher volatility. However, having a long vol bias in the portfolio has not been the ideal strategy to deal with recent “uncertain” events. Over the past year, European investors have had to deal with the Brexit referendum, the Italian referendum, and now the French elections. The vol environment during each of these events has failed to yield positive returns if an investor had outright bought volatility across tenors.


What to watch out for? While the German elections have attracted only little attention from financial markets so far, the unexpected rise in the popularity of SPD leader Martin Schulz in recent polls has potentially been one of the reasons for the vol hump seen around the Sep17 VStoxx future. We believe that the Aug/Sep/Oct fly is an attractive strategy. It should perform well if some investors start to pre-position on the September VSTOXX futures/October SX5E maturity, but has only little risk embedded (approx 1 vol point) should the curve normalize.

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