After American politics, markets are now focused on European politics with risks surrounding the French election.
Bund / OAT spread is widening slowly a bit more each day: it was 30bps early November, 50bps early 2017 and 73bps today. Markets fear that the winner could be a party in favor of returning to the French Franc, and given the very high uncertainty, this scenario will probably be hard to get rid of before the election. In short, if we follow this logic, there is not much good news to be expected from Euro politics over the short term and it is hard to imagine French spread coming back significantly.
Logically, this backdrop weighs on Euro equities and banks, even though micro earnings are decent. That is probably the most difficult issue today: macro data is robust, micro data is decent, but there is a sword of Damocles hanging over our heads.
Even if it is impossible to have a clear cut view regarding political risk, we think we will probably see things deteriorate. That is why we have cut our equity risk, periphery spread risk and moved some of our BOBL shorts (German rate future) to OAT shorts. We have in the meantime increased our exposure to short Gilt vs T-notes spread.
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