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GRAPHIC-French political risk finally shows in equity markets
February 14, 2017 / 2:33 PM / 7 months ago

GRAPHIC-French political risk finally shows in equity markets

* European equity volatility picks up, esp relative to U.S.

* Equity markets so far largely sanguine on political risk

* VSTOXX term structure: reut.rs/2kFHnRi

* VSTOXX vs VIX: reut.rs/2lLlhgm

By Kit Rees

LONDON, Feb 14 (Reuters) - A spike in expectations of European equity market volatility around the first round of France’s presidential election suggests investors are belatedly starting to worry about the outcome and potential price swings.

European equity markets, marching to the drumbeat of a global rally, have remained relatively sanguine even as uncertainties around the French election have jolted bond and foreign exchange markets.

The term structure, which charts expected price swings using options pricing for the most commonly used index for European equity market volatility, the VSTOXX, shows a noticeable steepening around April expiries, as this chart shows.

Chart: reut.rs/2kFHnRi

Moreover, the VSTOXX is also diverging from measures of U.S. equity market volatility with the ratio of the price of April futures on the two indices comparable to levels last seen before the Brexit vote and the euro zone debt crisis, according to Goldman Sachs.

This is partly explained by a spike in the cost of buying puts relative to calls on Euro Stoxx 50 futures, suggesting equity investors are increasingly looking for hedges against a potential drop in European stocks.

Chart: reut.rs/2lLlhgm

French bond yields have risen sharply in recent weeks from a low of 0.66 percent in early December on the possibility of a victory for anti-euro far-right leader Marine Le Pen when two rounds of voting begin in April.

French and European equity indices, however, have drifted higher with investors focused on corporate earnings, a brighter outlook for banks and a pick-up in regional economic growth.

The main French bluechip index is up nearly 13 percent over the past three months and is close to hitting its highest since December 2015. Earnings expectations for French bluechips have also ticked higher and are now positive for the first time since the summer of 2015.

That optimism could be tested in coming months.

The latest Bank of America Merrill Lynch survey of European fund manager shows sentiment towards French equities dropped to its lowest level in almost two years and the CAC 40 was the least-preferred equity index in Europe.

Expectations of volatility in European stock markets have lagged currency markets, Goldman Sachs said, with the euro in particularly choppy since the U.S. election as euro zone political risks came to the fore.

While signs of volatility are appearing in equity markets too, Goldman Sachs, said foreign exchange remains the best hedge against political risks as were sterling during Brexit and the Mexican peso during the U.S. election last year. (Editing by Tom Heneghan)

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