LONDON Investors are buying French inflation-linked government bonds and selling French debt linked to rising euro zone prices to hedge against the risk of France leaving the euro, as a fractious presidential election approaches.
Anti-euro far-right leader Marine Le Pen has an outside chance of winning the election, polls and betting markets show, and wants to take France out of the single currency.
Trading of French inflation-linked bonds - instruments whose coupons are linked to consumer price rises - shows investors are buying bonds pegged to domestic price increases and shunning those tied to euro zone inflation.
The theory is that if France leaves the euro, a new French currency would depreciate and inflation would accelerate, just as sterling fell and UK inflation picked up after the Brexit vote, said a government bonds trader at a major bank, who spoke on condition of anonymity.
"It's quite a clean re-denomination trade, and there are very few trades like that out there," he said. "Investors are willing to pay that premium for a very clean hedge."
As this graphic reut.rs/2nlMO9o shows, the breakeven rate - the yield spread between inflation-linked bonds and their nominal counterparts - on a bond linked to French inflation, maturing in July 2023, is 144 basis points. This compares with 131 bps on a French bond maturing in July 2022 and pegged to euro zone inflation FR0010585901= FR0010899765=.
An inflation-linked bond pays a coupon plus inflation so if, as in France, the breakeven is less than the inflation rate, it suggests investors expect price increases to speed up.
"We are currently receiving 10-year French inflation and selling 10-year euro zone inflation," said Cosimo Marasciulo, head of European fixed income at asset manager Pioneer Investments. "We like this trade because it works even if Le Pen loses the election."
Even if centrist Emmanuel Macron takes power, he will probably enact measures that push up French inflation, Marasciulo said.
The most recent opinion poll shows Le Pen taking 27 percent of the vote, ahead of Macron on 25 percent in April's first round and Macron beating Le Pen by 62 percent to 38 percent in May's run-off.
(Reporting by Abhinav Ramnarayan, graphic by Nigel Stephenson, editing by Larry King)