Wall Street is always ready for the next leveraged blowup…
And after what happened with Situational Awareness in July… everyone expected more AI related trades to implode…
But this week it came from an entirely different financial area…
French government bonds.
Government bonds are about as dull as investing gets…
You lend a country money… it pays you interest… and you get your cash back at the end.
Nobody seriously expects France to stop paying in the next five years.
That was the exact bet that blew up…
For years, France paid investors a little more interest than Germany did.
And certain Hedge funds built a trade around that gap…
Buy French bonds, sell German ones, and collect the difference as the two drift back together.
In the industry, this gap was known as le spread.
The difference was small… so they borrowed heavily to make it worth their while.
Over the summer, the funds piled in. They figured French politics couldn't get much rockier before next year's presidential election.
But it did.
Marine Le Pen's lead in the polls kept growing… and the Macron government's budget plan went down badly.
And then to make things worse… Government bonds sold off around the world at the same time. So instead of narrowing, the gap blew wide open. By Friday, French 10-year bonds were paying 1.55 percentage points more than German ones.
Meaning Le Spread was Le Screwed
And so the trade went wrong… meaning hedge funds were forced out of their positions at huge losses…
So much for smart money…
As always… when leverage is involved, when you’re wrong… you’re really wrong. Because when you’re leveraged 25x - a 4% move wipes you out…
No matter if you’re trading obscure penny stocks or a so-called safe instrument like French government bonds…
Oliver