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The Best Ways to Hedge the Risk of an Italian Election Upset

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Investors may have grown complacent about the tail risk surrounding Italy’s looming general election and should protect themselves against any upset, according to Mizuho International Plc.

The best way to do that is to bet on the widening of the spread between Italian and French 10-year bonds, the Japanese bank wrote in a note to clients on Wednesday. Other good options include shorting the euro versus the dollar, going long German swap spreads and shorting Italian equity indexes. While there are few signs overall of investor concern ahead of the March 4 vote, there are indications of some pre-election jitters.

“It seems that this benign view is strongly priced into the market already,” wrote Peter Chatwell, Mizuho’s head of EMEA rates strategy. “However, there remain asymmetric risks.”

Polls published before a two-week blackout period started pointed to a hung parliament, with the anti-establishment Five Star movement as the leading single party, but trailing the center-right coalition led by four-time former premier Silvio Berlusconi.

The yield on Italian 10-year debt was little-changed at 2.07 percent as of 10:09 a.m. in London, having risen five basis points this year. The premium investors pay to hold the notes over similar German securities widened to 139 basis points, the highest level in five weeks, after touching the lowest since September 2016 earlier this month.

Mizuho said it targeted the yield gap between France’s October 2027 government bond and Italy’s September 2028 notes to widen to 100 basis points from 88 basis points using a ratio spread. In terms of using the euro as a hedge against tail risks, investors should target a fall to $1.18, Chatwell said. The currency declined 0.1 percent to $1.2312 on Friday.

— With assistance by Marco Bertacche

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