LONDON, Feb 8 (IFR) - Open interest in futures contracts referencing French
government debt hit record highs this week as a turbulent presidential election
campaign drove yields on 10-year French OATs to their widest spread over German
Bunds for more than four years.
Activity in Eurex-listed euro government bond futures has surged since
November’s US presidential election, but a French election race plagued with
scandal has further accelerated trading in OAT futures. With more than 561,000
contracts outstanding as of Monday's close, activity in the contracts is now
outstripping Italian BTP futures, cementing the instrument's position as a key
tool for investors to hedge risk and trade relative value.
"There has been a secular trend towards government bond futures as banks
find it more difficult to provide liquidity in cash instruments," said Anton
Heese, head of European rates strategy at Morgan Stanley. "A lot of big macro
hedge funds got more active in the government bond space at the end of last year
and they typically prefer to express views in futures as they’re easier to trade
Ten-year French OAT yields traded as wide as 78bp over German Bunds this
week amid the rising political uncertainty. Conservative candidate Francois
Fillon and centrist candidate Emmanuel Macron are struggling to fight off recent
scandals, leaving National Front candidate Marine Le Pen, who plans to pull the
country out of the single currency and hold a referendum on EU membership,
topping polls for first-round voting on April 23. The final run-off takes place
on May 7.
“French markets continue to see more volatility from heightened political
and event risk with French versus German spreads widening to their widest since
2013. This is a theme that looks set to continue,” said Lee Bartholomew, head of
product R&D fixed income at Eurex.
For investors, OAT futures are a welcome alternative to credit default
swaps. While something of a blast from the past, having been actively traded
before the single currency signalled their demise in 2000, their revival kicked
off with the 2009 launch of BTP futures as Eurex spotted an opportunity for
investors to trade divergent yields across eurozone government debt. The OAT
contracts followed in 2012, just ahead of the last presidential election.
French politicians, including Le Pen and current president Francois
Hollande, slammed the contracts at launch on the basis that they could encourage
speculation on French debt and push bond yields higher.
Traders quickly embraced the product, however, both as a proxy for
pan-eurozone debt markets and an alternative to sovereign CDS following European
Union rules that outlaw naked positions in CDS contracts. That ban means CDS can
only be held as a direct hedge against bond positions rather than as a trading
tool to express relative value on government bond yields.
Liquidity in single-name CDS has shrivelled since the CDO heyday. The
product remains largely bilateral and is capital-intensive for dealers as a
result. From March 1, all swaps participants will be forced to exchange
variation margin on uncleared swaps exposures. While that should force more CDS
trades into central counterparty clearing, many buyside firms lack the liquidity
to meet clearinghouse collateral requirements.
"The move towards liquid, listed instruments is happening across a range of
products in the fixed income space," said Heese. "A lot of investors are
changing the manner in which they operate and the move to central clearing has
been difficult for many investors given the collateral that they need to post."
While liquidity in single-name CDS has shrivelled in recent years, French
sovereign CDS remains one of the most active single name contracts, with gross
notional outstanding of almost US$70bn last week, according to DTCC data.
(Reporting by Helen Bartholomew)