The Economist Riff of the Week: France

"To source my stories, I read a tremendous number of books and papers, I subscribe to research services, and I read The Economist religiously"

Jim Leitner, Founder of Falcon Management

In Stephen Drobny’s book, “Inside the House of Money”, Jim goes as far as to say that he could trade pretty well if his only news and research source was The Economist. I’m not here to deify the magazine--I would tend to concur with those that think their agenda has gotten a little tiresome.

That being said, I would agree that if you are going to read one thing all week, The Economist should be it. As a public service this is the first edition of a new MM feature, "The Economist Riff of the Week.”  



The story notes how Macron’s “En Marche!” movement has taken the lead in polls for parliamentary elections, and now looks likely to win a strong majority. The first round was yesterday, and Macron did indeed win a huge victory, one that pollsters project will win him between 415 and 455 of the 577 seats in parliament.

Macron has been given the mandate to implement his agenda. From a macro perspective, the three most important planks of his platform are fiscal policy, labor reform, and pension reform.  Macron has promised to put “France back to work”, increase productivity, reform what was once thought unreformable, and fix France’s broken growth model. But what does he really stand for?

Fiscal policy--Here are some quotes from Macron’s economic platform:
“We will therefore reduce the share of expenditure in national wealth to 52% in 2022: the difference between the level of expenditure in France and the average level in the euro area (48.5%) will thus be reduced by half;”

Alright--Macron wants to reduce government spending--to a level which is still 3.5%/GDP above the Euro area average . At least he’s pointed in the right direction. How’s he going to do it?

“Public spending will be reduced by EUR 60 billion per year by the end of the five-year period.
This is done via three channels:
  1. The social sphere: 25 billion euros in savings. With the reduction in unemployment (aiming at a rate of 7%), unemployment insurance expenses are automatically reduced. With health insurance spending contained at 2.3% per year thanks to better prevention and better coverage of care, a saving of 10 billion euros is foreseen.
  2. The State: 25 billion euros of economy, modernizing the civil service and aiming for a realistic and differentiated reduction of the posts in the public civil service.”


Both about 1%/GDP. #2 sounds pretty vague and squishy. And in #1, Macron is claiming 25bn euros in savings by reducing unemployment to 7%. Let’s look at his assumptions:


He is forecasting 1.7-1.8% GDP growth for 2018-2022. Here’s how France has grown for the prior five years:

GDP growth hasn’t cracked 1.5% since 2011--so optimistic at best. Where will this magical growth come from? Macron believes labor and pension reforms will reduce labor expenses enough to make the economy more competitive, especially with their Teutonic neighbors to the east. But Macron’s labor policies look like tinkering to me--hardly the tough medicine necessary to change a chart like this:


Same story on pension reform--Macron is essentially suggesting to streamline the system rather than change it radically. Not a bad idea, but hardly a radical one.

Macron claims he is “neither right nor left”. Indeed, he is Tony Blair, not Maggie Thatcher. But France needs a Thatcher.

Accordingly I’m not bulled up on France here--but given the recent volatility and the big victory yesterday, it is worth it to roll through some charts.

This is 10y and 30y OATs vs. Bunds. If you really buy into the “New France” story, there is good value for more tightening here. I could see trying to buy the 10y oat vs. 10y bund at a 35bps spread looking for a move to the mid 20s, but I’m not crazy about it.

There’s some directionality with outright Bund rates--but in the recent range the spread has traded tighter from current levels, and the future outlook for France is certainly better than it was in late 2014-early 2015 when there was a ton of Asian demand for OATs.

Another clever idea would be a 10s30s OAT flattener--this is trading at the top of the range, along with Bunds, which is interesting given the huge flattening in USTs over the past month or so. If Macron delivers on reforms, 10s30s will flatten, and you are getting a nice entry point here.

French bonds also look at little cheap vs. Belgium.



No home runs here--but maybe a few clean singles good for 8-10bps. Chime in if there are any great insights out there--or let me know what caught your eye in the Economist this week.
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Rossco
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June 12, 2017 at 7:54 AM ×

The Economist. With all due respect, you have to be joking?

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Martin Ghoul
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June 12, 2017 at 11:45 AM ×

Have you considered the roll and carry on the 10s30s OAT flattener? Given that (as well as the uncertain payoff, IMHO), I am not all that sure that it can be considered such a clever trade.

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River
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June 12, 2017 at 6:19 PM ×

Second revolution in France?

"France Is on the Verge of an Astonishing Political Transformation"

France’s traditional powers headed for crushing defeat

https://www.bloomberg.com/politics/articles/2017-06-11/macron-tightens-grip-on-france-as-voters-offer-assembly-majority


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johno
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June 12, 2017 at 9:05 PM ×

You make some good points re Macron, Shawn. Thank you for the post.

I didn't think the carry/roll on the 10s30s flattener was so objectionable, however, my guess is it's more a bet on tapering. Also, comparing curve shape against Germany, the French 10s30s is towards the low end of its range since 2015.

Your post is timely when thinking about market reactions to the weekend news of Macron's majority, and the surprisingly bad showing of 5-star in local elections (killed!). EURUSD is basically unchanged and European stock markets bled lower during the day. Maybe market was too aggressively positioned for a narrative that Shawn points out is highly questionable. I'd add that to the extent European growth is a derivative of Chinese growth, you have to be worried that 1) the Chinese credit impulse points to lower global PMIs from here and 2) the Chinese yield curve is inverted.

My thought that GBPUSD could bounce on a soft Brexit narrative today fell flat. Took at 50 pip loss and bailed.

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Shawn
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June 13, 2017 at 12:20 AM ×

Yeah, Martin-- maybe a poor choice of words--the 10s30s flattener is a "clever" trade if you buy into Macron over-delivering, which I think is not implicit in his milquetoast platform. The flattener fits with the potential for a slowdown in Chinese demand--and correct me if I'm wrong here Johno, but looking at the chart above it the 10s30s oat/bund box looks middle of the range going back to 2013. So not overly compelling, but good risk/reward if you buy into the "New France" theme.

Re: carry/roll, I see carry like -1bp for 3 months, which doesn't sound like much--roll...well don't get me started on roll (or maybe i'll save it for a post). It is a worth noting that the 10y looks cheap on the curve--not sure if that is because of the auction on Thursday or not--but maybe 7yr would be a better iteration for the short leg. The auction schedules set up better for the OAT/BGB spread given some pretty chunky supply coming next week in Belgium, which would also get away from the point on carry/roll.

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abee crombie
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June 13, 2017 at 3:57 AM ×

Johno re eu growth = China growth. Very much agree. I look at eu industrials. So far so good, but I am cautious, as all signs pointing to peak about now. I was looking at Asean exports today. Me thinks peak too.

Tech did as expected today. Dip buyers came in but nothing major. According to the esteemed Cramer this should be a 3 day event. So by end of week we should have some clarity. Russell also setting up nicely. But nothing else macro seems to worried today. But I have a feeling momo names are about to get crushed more. If the market can rotate and not fall too much then it's fine, if not watch out below. Financials and fed will be key, imo. Financials want a hawkish fed, but be careful what you wish for.

Mm had a nice post on cad. Nice move today. Positioning is one way. Here comes the squeeze.

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Leftback
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June 13, 2017 at 4:34 PM ×

In the days of yore, with TMM 1, we used to consider The Economist cover illustration as a counter-indicator, e.g. a battered George Washington meant that it was time to buy USD as the move was now probably over….

LB is once again yawning, awaiting the long bond auction, and wondering what dumb ass positions punters will have got into ahead of the Fed's presumably dovish hike tomorrow. [Hike plus slightly less hawkish dot plot?].

Returning to a recent concern, here is a real life interview with a real life tiny punter and vol seller…. one wonders if they ever sit down and do the calculation about what happens to their life if it all goes Pete Tong..?

https://www.wsj.com/articles/you-dont-know-vix-wall-streets-fear-gauge-is-now-a-multibillion-dollar-market-1497281745

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Polemic
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June 13, 2017 at 6:27 PM ×

THE UK and France are heading in different directions. France is trying to shake off years of socialist policy which has seen business restrained by well meant social policy and the UK, judging by the last election has sen a large swing of support from the younger generations towards marxism, is looking for something that would look more like France.

The problem is that both new movemente are built on idealism that would see both countries going through a schism of transition that will cause it's own derivative backlashes.

TBH if I was to be totally practical about this both countrues should stay the same with those supprting the French way moving to France and those the current British way moving to the UK. But as ever folks actually want the best of both worlds and that is very very hard to achieve, unles you are Singapore!

johnno. gbp.. you should have hung on sir. I feel you may have fallen victim to the old time benchmark mismatch in trading a longer term macro views with a 1 day stop loss.

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Polemic
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June 13, 2017 at 6:34 PM ×

LB - Thank you for reminding the audience. The Economist cover is ranked even higher than the "Economists (not the mag) letter of endorsement' reverse indicator of election success.

OH and while we are on negative indicators. Pikkety, has everyone finally worked out that his work was a complete red herring yet?

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IPA
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June 13, 2017 at 6:38 PM ×

May 24th was the day to cover CAD short. BOC sent a loud message back then to get the heck out of the way. Not sure why anyone would want to fight them.

I pared down the XRT as this "rotation" may take it up to $44 resistance before sending it back down below $40 and eventually to $35. Nobody ever lost money taking a profit. Half is still intact, but a man has to eat lunch and take a vacation.

ULTA is another story, not letting any of my short go until they carry me out feet first or I make a killing (don't get too excited HH, just on this position, not my entire acc). A firing squad stands @ $299 and not letting through. Once below it should fill the $293 gap and may go test $280-277 area. My target is $250.

I am adding to XLE here. I think they are getting ready to push it up through 50 dsma. Still think crude goes back above $50 and stays up there. My XLE target is $80.

Folks, I am on vacation through the end of August. I wish everyone a great summer!

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River
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June 13, 2017 at 7:54 PM × This comment has been removed by the author.
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River
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June 13, 2017 at 7:55 PM × This comment has been removed by the author.
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River
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June 13, 2017 at 7:58 PM ×

@IPA. Happy holidays. Hope to see you soon

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Shawn
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June 14, 2017 at 1:52 AM ×

One could, and certainly should, use the cover as a contrary indicator--Leitner's point was it is an investing tool, not a sack of research recommendations to be taken without rational criticism: e.g. every cover ever on Brazil.

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SRUN POR
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June 17, 2017 at 4:58 AM ×

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