* Anticipation of Hollande victory weighing on bond, stocks
* Forex traders lay down bearish bets eyeing fiscal slippage
* Equity market to see winners and losers, volatility rise
By William James and Simon Jessop
LONDON, April 19 Financial markets are unlikely
to greet the expected election of a Socialist French president
with enthusiasm, except perhaps those placing early bets that
bond yields will rise, the euro will fall and equities will be
With the first round of voting on Sunday, Socialist
candidate Francois Hollande is poll favourite to win on the
second round on May 6, raising concerns that his grip on
government finances will be lighter, and a euro zone agreement
on fiscal discipline might be unpicked, though his campaign team
has backpedalled on earlier pledges to renegotiate it.
Not that many take a much better view of the incumbent
conservative Nicholas Sarkozy, whose fiscal plans, like
Hollande's, rest on growth projections that economists polled by
Reuters consider over optimistic.
Much of the difference between their deficit reduction
programmes is a matter of timing; Hollande plans to balance the
books by 2017, while Sarkozy is targeting 2016.
Economists in the Reuters poll don't expect either of them
to get there on what they've promised so far.
"If we don't see a reversal of campaign statements after the
elections, then we could possibly see a market attack," said
Marie Diron, economist at Oxford Economics.
"More and more clients are calling us to get products linked
to the election," a Paris-based equity derivatives trader said.
"Everyone sees the risk on the downside for French assets,
because if Sarkozy gets re-elected, France's deficit problems
won't be resolved overnight, while with Hollande, the fact that
the deficit reduction doesn't seem to be his priority is nothing
to reassure investors."
Confidence in the euro zone is already running low, with
Spain's shaky finances threatening to drag the region back into
crisis and prompting investors to retreat from assets that could
suffer by association.
Sarkozy warned last week that a Hollande victory would set
off a crisis of confidence, a view his challenger derided as
encouraging speculation for personal gain to the detriment of
France. Central bank governor Christian Noyer said he saw no
reason for markets to attack France, as long as "the clarity,
persistence, and priority of the (debt reduction) path is
Many in the market have got their reaction in ahead of the
result; in a month-long move away from riskier assets, French
bonds have fared worse than other core euro zone countries, and
the benchmark cost of insuring French debt against a default has
broken above 200 basis points for the first time since January.
On the stock markets, France's CAC 40 index has
underperformed the German and UK equivalents,
while expectations of wilder swings for the French index have
risen by 50 percent in the last month.
The volume of French shares out on loan, a proxy for
activity by short-sellers, who aim to profit from falling
prices, has also risen markedly.
Data Explorers said short interest had risen 4 percent over
the last month to 3.25 percent of the CAC, with advertising
group Publicis the most shorted stock, with a 40
percent jump in short interest in the run-up to its results on
Some currency traders, meanwhile, have been placing bets
designed to profit from a fall in the euro on May 7, the day
after the final round of the presidential election, highlighting
the wider impact a Hollande victory might have.
The trade involves investors buying euro/U.S. dollar options
that give them the right to sell the euro at $1.25.
With the single currency last trading around $1.31, the
value of the option would increase on any fall towards $1.25
over the next 18 days, allowing it to be sold on at a profit.
Traders have already cited significant selling of French
bonds that coincides with the falling away of Sarkozy's
challenge to Hollande's healthy opinion poll lead.
"We wonder if French fund managers have decided that the
Sarkozy bounce isn't going to happen, and they're going to start
taking some preventative action, because the markets might try
and give Hollande a rough ride very early on," said one
London-based bond trader.
Royal Bank of Scotland bond strategists recommend a trade
designed to profit from a rise in French 10-year bond yields
relative to Germany, targeting a gap of 160 basis points between
the two. The spread last stood at 140 bps.
As investors look to mitigate the risk that a Socialist
victory undermines bond market investor confidence, the price of
credit default swap insurance contracts - a popular risk-hedging
tool - could rise as high as 220 bps, according to Bank of
America Merrill Lynch.
With Hollande looking to increase spending in some areas to
help boost growth, the outlook for equity markets is potentially
more mixed, prompting investors to single out companies and
sectors likely to be affected by policy shifts.
UBS see potential stock winners in the housing and
construction sector, for example electrical fitting maker
Legrand, while losers could include Thales,
Europe's largest defence firm.
Citi's political analysts pinpoint banks, insurers and the
nuclear industry as the sectors most likely to be hit.
To mitigate the election impact, Credit Suisse advised
clients to buy firms with more than 30 percent of sales outside
continental Europe, citing concerns about the French economy,
including a poor record on deregulation, an expected rise in
corporate tax and high labour costs.
Holding on to the view that a new president will produce
both winners and losers, an alternative way to profit from the
expected turbulence is to use equity derivatives to bet that the
spread of returns on stocks will widen using a call option
structure, BNP Paribas said.
"The CAC itself will have some stocks that will perform well
and others that won't, so net-net they could cancel each other
out ... So playing an absolute dispersion trade could be more
interesting than simply having a directional view on the index,"
said European head of equity and derivatives strategy, Kokou