Spreads Widen Further As Political Uncertainty Dominates Into First Round Of Voting

The 10-Year OAT/Bund spread widening has extended further today, last printing just below 85bp, with the August '12 closing high breached

• Political/fiscal paralysis, with French finances already in question, provides the greatest source of worry for market participants ahead of Sunday’s vote.
• Opinion polls still have RN in the lead, with President Macron’s alliance adrift in third place.
• Some pollsters have alluded to the potential for an RN majority, although the two-step nature of the electoral process provides an additional layer of uncertainty here.
• Our political risk team’s full election preview can be found here.
• A “cohabitation” outcome would continue to embed political risk premium into OATs in the coming weeks/months, limiting the scope for meaningful spread tightening.
• Any degree of power for the leftist alliance probably presents the greatest threat to markets, in our view, and could quickly move focus to the 100bp area in the OAT/Bund spread.
• Short positioning in OAT futures remains relatively elevated, based on inferences from OI data, albeit off June extremes. This provides the potential for a contained relief rally if the leftist alliance fails to attain any power.
• ‘Frexit’ is less of a concern than in the ’17 election cycle, with RN moving away from that idea in recent years. This can be evidenced by the basis spread between French CDS contracts governed by ’03 & ’14 conventions (see figure 2, below)

Fig. 1: 10-Year OAT/Bund Spread (bp)

Source: MNI - Market News/Bloomberg

Fig.2: French CDS Basis Spread Based On ’03 & ’14 Conventions (bp)

Source: MNI - Market News/Bloomberg