Tuesday, April 18, 2017

Twice-Bitten Traders Take No Chances With French Election Risk

Goldman, Deutsche Bank recommend selling French debt into vote; Pimco says selling euro versus Swiss franc is ‘logical hedge'

By Stefania Spezzati
April 18, 2017

After last year’s political shocks from the U.K. and the U.S., investors are taking no chances with the risk of a French version.

As France’s most unpredictable presidential vote in a generation looms less than a week away, banks and asset managers are building defenses against a win for anti-euro candidate Marine Le Pen even as polls suggest it’s unlikely. Bracing for a political upset similar to Brexit and Donald Trump’s victory, they are positioning for potential declines in the common currency as well as France’s government bonds.

Goldman Sachs Group Inc., Deutsche Bank AG and Nomura Holdings Inc. have recommended selling French debt into the two-round election, to be held on April 23 and May 7, while Fidelity International has already trimmed holdings. Pacific Investment Management Co. says selling the euro versus the Swiss franc would be a “logical hedge” and Dubai-based hedge fund Ark Capital Management has bought options that allow sales of the single currency should it weaken sharply.

“The question is, can we deal with a third black swan?” Enda Homan, senior foreign-exchange trader at Allied Irish Banks Plc in Dublin, said in an interview, using the metaphor for an unforeseen catastrophe that was popularized by Nassim Nicholas Taleb’s 2007 book with the same title. Homan, who worked overnight for Brexit and the U.S. election, has no similar plans yet for the first round of the French vote. Still, “it could all change if the fear factor spikes as we get closer to the vote,” he said.

National Front leader Le Pen and independent Emmanuel Macron have been leading the first-round polls, followed by Republican Francois Fillon and far-left candidate Jean-Luc Melenchon. Macron is tied with Le Pen with 22 percent support for the first round of the election, according to an Ipsos/Sopra Steria poll for Le Monde. Second-round polls are signaling a victory for Macron.

Euro At Risk

The cost of one-month options to buy the euro against the dollar has plunged, relative to contracts for selling, to the lowest level since the height of Europe’s sovereign-debt crisis in 2011, signaling increased hedging against potential losses. The so-called risk-reversal rate, a gauge of market positioning and sentiment, has slumped to minus 395 basis points, from minus 44 basis points at the end of 2016.

Earlier this month, a survey of analysts predicted that the euro will tumble to a 15-year low if Le Pen becomes President. The yield premium investors demand on France’s 10-year bonds over German bunds has increased to 71 basis points from as low as 27 basis points before Trump’s U.S. election win in November. French debt due in November 2026 yielded 0.92 percent as of the London close on April 13.

Scott Thiel, deputy chief investment officer for global fundamental fixed income at BlackRock Inc., the world’s biggest money manager, favors hedging potential euro losses on a Le Pen victory by buying put options, he said at a press briefing in London on March 29.

Fidelity has cut its exposure to French debt even as its base case is that Macron will win, according to London-based portfolio manager David Simner.

‘Logical Hedge’

Investors may find it more expensive to trade regional assets after the vote. Danish lender Saxo Bank A/S is mulling an increase in the margins it charges retail customers on trades in the euro and European equities indexes to 4 percent after the first-round vote, it said in a memo sent to clients.

“We don’t see a negative surprise from France but there are of course risks,” Thomas Kressin, Munich-based portfolio manager at Pimco, which manages $1.5 trillion of assets, said in emailed comments. “Long Swiss franc and short euro would be a logical hedge trade against the tail-risk scenario of a Le Pen victory. It’s a position with asymmetric risks. If things don’t go wrong in the euro zone, you don’t lose much. If they do, you may gain.”

Pimco declined to comment on the fund’s positions.

Cautious Optimism

Equity strategists and investors are more sanguine, with Bank of America-Merrill Lynch, JPMorgan Chase & Co., Barclays Plc and Jefferies Group favoring European stocks despite French election risks. They cite global asset managers’ low positioning on European shares, the stocks’ cheap relative valuation as well as the region’s brisk earnings recovery as reasons for the optimism.

Still, investors remain cautious ahead of the vote, with the cost of hedging against declines in the Euro Stoxx 50 Index recently rising to its highest level since the Brexit vote.

While most of the banks are still predicting a market-friendly outcome for the vote, the gap between the main candidates is not large enough to exclude a surprise, according to Deutsche Bank, which holds a short position on three-year French bonds.

Ark Capital, which has bought “low-delta” put options on the euro, is also selling the single currency against major peers including the pound and the Canadian dollar, Saed Abukarsh, co-founder and chief portfolio manager, said in an interview.

“Nothing can be taken for granted,” said Nicholas Wall, portfolio manager at Old Mutual Global Investors in London, who is selling French bond futures into the vote. “If there is a shock victory for Le Pen or Melenchon, the yield on French bonds should rise dramatically.”

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