French Fries Protip: Don’t Worry About The Second Round, Worry About The First

For all the global hand-wringing about a possible “nightmare” runoff in the French elections pitting Le Pen against Melenchon…

secondround

(BofAML)

… it would appear that traders are actually more worried about the first round.

“Rising premiums for front-end euro puts versus the dollar and the yen reveal traders see the first round of French elections as bearing the greater risk,” Bloomberg strategist Vassilis Karamanis wrote this morning, adding that “the spread between onemonth and oneweek 25d risk reversals in EUR/USD rose on Thursday above par for the first time this week.”

RiskReversal

He continues: “It trades at +0.17 vol, compared to -0.15 vol on Wednesday and -0.11 vol when the oneweek tenor first captured the elections.”

That’s either silly or tautological, or a bit of both because after all, it’s the first round that determines who’ll be in the second round, so yes, it makes some measure of sense that people would be worried about the first round first.

There’s some fun mental acrobatics for you on a Thursday morning.

Below find some more color on why the above makes sense from Bloomberg’s Mark Cudmore.

Via Bloomberg

The very recent rise of Jean-Luc Melenchon means that risks around the French presidential election are under-priced, but complacent bulls are unlikely to be punished. They won’t need to wait until the second round to know their plight.

  • Marine Le Pen has been a massive red herring for macro tourists when looking at the French presidential election. While she’ll probably get through to the second round, she’s extremely unlikely to be president. The polls have been consistent on that front
  • Knowing this has meant that many strategists — myself included — have largely dismissed the hype over the presidential race. As a result, the market has under- appreciated the latest dynamics
  • Melenchon now has a genuine chance of reaching the second round and, in purely markets terms, he would be as bad, if not worse, for French and European assets. Crucially, polls suggest that if Emmanuel Macron stumbles, the leftist would beat both Le Pen and Francois Fillon in a second-round runoff
  • This has happened so recently that investors aren’t adequately hedged for such an outcome. However, while momentum is on Melenchon’s side, he’s still far enough behind to be very unlikely to qualify for the run-off
  • The other important corollary is that all the risk is really around the first round result, rather than the second round. As long as Melenchon doesn’t get through and Le Pen doesn’t end up winning by a surprising margin, investors can relax from Monday onwards
  • The base case -– Le Pen and Macron into the second round — is a positive outcome for risk even if Le Pen-related headlines might cause some initial hesitancy among investors. Same for Fillon versus Le Pen. And if it’s Fillon versus Macron, then we won’t even see that hesitancy. It’ll be another green light for risk to rally globally
  • I’m very confidently expecting a positive outcome for European assets from Sunday’s election. But that’s not to say now is the time to pile in. The risk-reward ratio isn’t great, given that Melenchon’s chances, unlikely as they are, are under-priced
  • Full disclosure: I got the U.S. presidential election result entirely wrong. I thought Trump had no chance of winning. I don’t think that’s relevant to the analysis here but I want to offer the context for use as wanted

 

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