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 and adjust.”
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)