So by now, those who frequent these pages are well aware of our views on the extent to which French election risk is priced into markets.
Put simply: it’s not priced in. Not even close. Not in equities, not in VSTOXX (although the kink in the term structure reflects some effort to position for a “sh*t hits the fan” scenario), and most assuredly not in € credit which, as the following chart from BofAML underscores, is just asleep at the proverbial wheel…
(hint: how much compensation would you want for taking on redenomination risk? if you said “more than ~15bps,” then that chart shows a notable mispricing)
So we know this particular event risk is woefully mispriced across assets. The next logical question is: “ok, so what happens if Le Pen manages to win and then pushes for ‘Frexit’?” Here to enlighten us on just that is Deutsche Bank or, more specifically, Deutsche’s clients.
Via Deutsche Bank
We recently conducted a global cross-asset survey (FX, rates, equities and volatility) about investors’ views of asset returns one week after the French Presidential election. Overall, we received 388 results globally, approximately 43% Eurozone, 38% UK, and 19% US/Asia.
To analyze our survey results, we initially asked respondents to identify what risk-on/risk-off scenarios they identify with particular political outcomes (Figure 2), as we did not want to pre-determine the impact of particular election scenarios. A Le Pen win was dominated by a ‘Very Negative’ (48%), or ‘Negative’ (43%) outcome. A Hamon/Melanchon outcome was also viewed negatively, but less so: ‘Negative’ (44%), or ‘Neutral’ (33%). Finally a Macron/Fillon win was skewed towards ‘Positive’ (73%). There are very few ‘Very Positive’ views for any outcome.
Equity index survey expectation: Figure 4 shows expected moves in European Equity markets. In the -ve scenario there is a significant tilt towards downside expectations, with Eurozone Banks (SX7E) and CAC40 having more extreme risk, in line with their higher betas.
Equity Vol (VSTOXX) survey expectation: Figure 3 shows in a negative scenario there is large expectation of a high vol regime, VSTOXX > 35 (34%). Notably in the positive scenario, although most respondents expect a vol range of 15-20% (57%), there is material expectation of a very low, sub 15%, regime (29%).