French Risks Mostly Localised After Recent OAT-Driven Spread Widening

EGB spreads to Bunds are off the widest levels of June, with the first round of the French elections initially providing some relief for markets, even as the potential for prolonged political uncertainty in the Eurozone’s second largest economy remains evident.

• Major EGB spread movement since the June 7 close suggest that EGB traders don’t view the French political situation as a meaningful systemic threat.
• This apparent lack of systemic risk will be playing into the ECB’s sense of calm over the OAT widening episode.
• Nonetheless, OAT/Bunds have only retraced ~20% of the widening given the political uncertainty and fiscal questions remaining in France.
• Dutch, Irish, Belgian and Portuguese spreads vs. Bunds have retraced over 50% of their moves, with DSL/Bunds and IRISH/Bunds leading, paring over 70% of their widening.
• BTPs have suffered from their typical high beta status, while local fiscal developments have also factored in, meaning BTP/Bunds has only retraced a third of the widening move.
• The table below shows the retracement of various EGB/Bund spreads from their post-June 7 closing wides, as of yesterday’s close: