Do you think the political risk into French election is priced more appropriately in bonds (but not in currencies) than going into the Brexit and the US polls?

In the remote scenario of a Le Pen Presidency with supportive government and Parliament, 10Y Bunds could approach 0bp and 10Y France-Germany 200bp, with sharply wider Bund swap spreads (54bp), FRA/OIS (20bp) and EURUSD cross currency basis (-60bp), and higher volatility (Bund implied 6bp/day).

Less extreme scenarios of Le Pen Presidency but cohabitation or extreme left Presidency will likely result in considerably less extreme outcomes.

A scenario of moderate market stress with either Le Pen or a unified left candidate achieving a 30%+ score, vs either Macron or Fillon (or the “Republicans” candidate called in replacement).

Alternative scenario: The acute market stress in a confrontation between Le Pen and a Hamon/Melenchon coalition. Regardless of the probabilities of occurrence of each scenario, we make simple arbitrary assumptions for each scenario in terms of market impact in order to rank the efficiency of vanilla EURUSD hedges.

In gamma space, we find that the concentration of vol risk premia in EUR/low beta pairs leaves a number of pairs that look cheap as good value proxy hedges for a contagion stemming from above scenarios.

After all, these would have profound implications for the Brexit process at the least. Indeed, GBPUSD gamma stands out as currently cheap, along with NZDUSD and CAD crosses (refer above diagram).

USDTRY also deserves a mention as a pair where gamma has been consistently realizing, and where the 16-Apr constitutional referendum is likely to provide further support to front-end vols.