FxWirePro: Luring shorts in EURJPY as the best political hedge

The political risk is tracked by the bookmakers odds, where the probability of a Le Pen win is stable around 30% (please refer above graph).

The medium/long-term impact on euro crosses highly depends on the materialization of a Frexit scenario. The impact of the French election is going to be extremely asymmetric on euro crosses, depending on the pro- or anti-Frexit outcome.

On the back these expectations, and in the aftermath of the Brexit vote and the Trump election, such a scenario cannot be qualified as a tail risk (unlike an actual Frexit). The OAT-Bund 10y spread has been closely following the spread between the winner’s odds and Le Pen’s odds (please refer above graph).

But there is now some risk premium in the bond market since Macron’s odds rose while the OAT-Bund spread did not materially tighten.

Indeed, there is much more volatility in Fillon and Macron voting intentions compared to Le Pen, keeping the market on guard.

All in all, the OAT-Bund spread should remain the best gauge for political risk and can be used to find the best FX hedge.