On Monday we brought you the latest from France, where fast approaching Presidential elections have been overshadowed by tension in the Korean Peninsula and airstrikes on Syria.
While we don’t know whether the US will engage Bashar al-Assad further or whether Kim Jong-un is on the verge of getting himself DEVGRU‘d, we do know that some folks are going to be voting in France and the outcome is anything but certain as indicated by (among other things) the ISDA basis…
For their part, Goldman recommends shorting OATs (see linked post above). But there’s more than one way to skin a cat. Below, find a summary of Street recos on how to play/hedge the biggest political risk in the developed world:
Via Bloomberg
With the first round of France’s presidential election drawing near, and risk slowly creeping back into markets, banks recommend selling the country’s bonds, or hedging exposure to its debt.
- Deutsche Bank doesn’t rule out a surprise outcome and keeps a short position on 3-year OATs heading into the first round of the vote
- JPMorgan hedges its long exposure to the country with non- France core wideners
- Deutsche Bank (strategists including Francis Yared)
- A historical analysis of the French presidential elections indicates that the current gap between the main candidates is not large enough to exclude a surprise
- From a market perspective, the lower probability/high impact surprises would be, on the negative side, a second round between Mélenchon and Le Pen and, on the positive side, a second round between Fillon and Le Pen
- The bank maintains short 3-year France, which provides a convex hedge against increased political risk in the country and with limited downside, given the potential repricing of the ECB after the election
- Maintains Eonia 2y1y-4y1y steepener as the pace of rate hikes priced by the market remains too low
- Maintains Italy 5s30s steepener as a positive-carry bearish trade on Italy
- JPMorgan (strategists including Fabio Bassi)
- The bank holds longs in a basket of France, Italy and Spain vs Germany and in Greece and Cyprus
- Hedge the risk of a Le Pen surprise with attractive risk-reward trades such as selective non-France core wideners, credit-curve flatteners, OW in low-coupon vs UW high-coupon bonds, long protection in 2003 5Y France CDS and long ASW BTPs vs CCTs
- Nomura (strategists including Yujiro Goto)
- French political risks are influencing Japanese investors’ foreign-investment stance, and they may stay on the sidelines for the time being
- Japanese investors sold ~$14.2b of French bonds in February, offloading long-term debt for the fourth month in a row
- This is also the biggest net selling since at least 2005, according to Nomura
- Selling was likely mostly on an FX-hedged basis, but likely put widening pressure on OAT-bund spreads
- Banks continue to hold tighter 2-year Schatz swap spreads and Eonia curve steepeners and maintain a short bias on 30-year OATs vs 30-year bunds and SPGBs
- Morgan Stanley (strategists including Anton Heese)
- Exit 5s30s bund steepener, but still like longs in 5y real yields given ECB’s exit from its monetary accommodation is likely to be slower than what the market prices
- Bank is moderating its bearish stance on euro zone by taking off short 5y5y breakevens, as it has sold off more aggressively than usual vs both short- and longer- dated forwards
- Lack of supply through the Easter period will be a bullish driver of breakevens in the near term
- There will be substantial OATei, OATi and BTPei supply surrounding the French election, along with reinvestment of OAT coupons, which together may weigh on breakevens, but the linker supply is likely to be well taken ahead of the extension upon the OBLi-18s falling out of the index
- Still like holding EUR 6m10y payer ladder as a way to position for higher rates and 5y forward 2s10s conditional bear steepener to earn carry
- Citigroup (strategists including Harvinder Sian)
- ECB-speak supports current forward guidance, especially on sequencing, but the debate is not closed
- The bank continues to hold ECB Sept. meeting pay EUR2y1y versus NZD and 1yr mid-curve Euribor puts
- S&P recently raised its outlook on Spain’s BBB+ rating from stable to positive, signifying prospects of an upgrade over next 24 months
- This represents another differentiating characteristic vs Italy and further supports cross-market outperformance of Bonos
- With the first round of French presidential elections just over two weeks away and opinion polls in Italy showing that 5-Star Movement has built a strong lead over the ruling PD party, market participants should brace for clusters of low levels of futures liquidity in the short/medium term
- Lower liquidity implies higher volatility and with bund June implied vol at the highest since mid-March, and at widest spread from corresponding swaption vol since early 2015, swaption straddles are a better (proxy) hedge
*******
And meanwhile…
h/t @lisaabramowicz1
