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Why 'Frexit' not Brexit should top bond investors' fears

Why 'Frexit' not Brexit should top bond investors' fears

The outcome of the French election and knock-on effect for the European Union should be higher on bond investors’ agendas than the current Brexit negotiations.

That is the view of John Taylor, manager of the AllianceBernstein Diversified Yield Plus Portfolio, who said he is positioning his funds to shelter from heightened political risks.

In a press statement, Taylor, who runs several funds at the US group, said investors should globalise their euro-denominated assets in preparation for French election instability.

Taylor said Brexit was currently dominating market thinking despite the triggering of the UK exit from the European Union having been long signposted.

Meanwhile, he said, far-right candidate Marine Le Pen’s pledge to lead France out of the European Union is being less considered.

‘A more pressing concern [than Brexit] is ‘Frexit’,’ he said. ‘Le Pen is polling well in the run-up to April’s presidential election and looks likely to win the first round. She has pledged to lead France out of the single currency.

‘However, even a Le Pen win would not make Frexit a foregone conclusion, as the Front National is unlikely to win sufficient National Assembly seats to enact her policies and such a decision would probably be subject to a referendum.’

Taylor said even if more moderate candidates, namely Francois Fillon or Emmanuel Macron, win the popular vote, there is still set to be instability in France.

‘A victory for either would not totally allay fears of instability considering the ECB has signalled a scaling back of QE to begin later this year or early 2018.’

‘Before the ECB initiated QE in March 2015 German bunds traded around 100 basis points higher in relation to US treasuries, so there could well be a shock if the ECB does not take care to introduce the scale down slowly.’

Taylor recommended ‘globalising euro-denominated assets’ to shelter from these political risks and to benefit from asynchronous cycles of inflation across the globe.

European corporate issues denominated in another currency in particular offer a wider credit spread than their domestic market,’ he added.

Taylor said credit-risk transfer securities (CRTs) from Fannie Mae and Freddie Mac allow investors to tap a strong US housing market, and possess floating rates, an appealing prospect as the Federal Reserve raised US interest rates.

Taylor said these securities do entail credit risk but provide handsome yields in return, while also being at the early stage in their respective investment cycles.

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