Political Change

The surprising political developments in France have slightly but discretely increased the riskiness of French assets.

After his party lost significant seats in the European parliament, President Macron surprised the world by calling for new national legislature elections. This created significant uncertainty in the political landscape, as polls suggest Macron’s centrist party is trailing far behind parties that either more strongly lean right or left. Both rising political forces are populist movements that strongly support increased fiscal spending even as France is already at a historically high 5.5% fiscal deficit.

The political turmoil has led to a discrete widening in the credit default swaps (increased risk of default) of France and French banks. Note the level of spreads remains low when compared to the thousand basis point spreads seen in some European countries during the European debt crisis.

The slight widening in CDS spreads also coincided with a slight rise in rates in key dollar funding markets, which usually reflect higher arbitrage costs.

The dollar euro FX swap basis widened slightly, implying a slightly higher interest rate for dollar borrowers who put up euros as collateral. Treasury swap spreads also tightened slightly, which suggests that Treasury yields increased relative to the expected path of policy.

The level of both spreads are in part determined by the availability of financing to market participants, as the trades themselves have little risk. Borrowing dollars and lending euros, or buying Treasuries and paying fixed rate swaps are low risk trades. However, the small spreads mean that the trades require significant amounts of leverage to be profitable.

The changes in spreads suggest a decrease in the availability financing, probably related to developments in France.

2/4