CHART OF THE WEEK
As we approach the French elections, there are several methods for measuring how the markets are pricing-in risk. Most are bond-market related, such as CDS levels or, quite simply, looking at the spreads of French bond yields over equivalent German bond yields. Another method is comparing out-of-the-money (OTM) put options (90%) on equities in the French CAC 40 with those in the German DAX.
This measures the premium that investors are willing to pay for protection against the risk of a steep fall in the CAC 40 as compared with the same risk in the DAX.
Until the beginning of February, protection premiums were similar. They widened sharply just after the revelations about François Fillon, the centre-right presidential candidate. Since March, however, the spread has tended to narrow. Government bonds and CDS levels also indicate that market tension has eased.
Markets now appear to be pricing in a lower likelihood of a “worst-case” scenario – the one that could result in a referendum on whether France should exit the Eurozone.
The opinion expressed above is dated March 27th, 2017, and is liable to change.
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