For the better part of three years, the hottest seat in London's multi-manager world was a European rates book: lever up French OATs in repo, clip the carry, collect the seven-figure payout. This month, the French bond market sent the bill.According to a must-read report from eFinancialCareers' Sarah Butcher, London's macro hedge funds are quietly emptying out their EGB desks.
Funds aren't talking about performance, but headhunters and bank traders who have been keeping score say the count of ejected European rates PMs and traders has climbed from the mid-70s a few weeks ago to close to 100 people. One senior trader at a liquidity provider summed it up in four words: "Everyone has blown up... they are all out"In other words, the most crowded trade in European fixed income just found out what happens when the collateral is the problem.
And the bleeding hasn't stopped. This morning Bloomberg flashed that the French bond risk gauge is nearing 160bps, a fresh 15-year high, while French 10Y yields hit 5% for the first time since July 2002.Below we walk through what blew up, why it blew up (twice), what Goldman, Morgan Stanley and the rest of the Street make of it, and why the market's attention is already drifting to the next domino: Italy.
The Trade: Borrow Against France, Pocket The DifferenceThe mechanics were simple enough to fit on a Post-it. Funds bought French government bonds, financed them in the repo market using those same OATs as collateral, and pocketed the gap between the bond's yield and the repo cost. Lever it up enough times and a few basis points of carry becomes a career.
Per eFC, as French yields rose amid political chaos, OATs sold off and the whole highly leveraged structure was turned upside down.A bank trader watching from the sidelines was less charitable:"These people weren't even real portfolio managers," claims one senior trader, watching from the sidelines in a London bank."They were just using EGBs as a carry asset.
Buying bonds, sitting on the carry and getting a percentage cut. It was fun for a while. You had a lot of PMs who were long France and long Italy, but with inflation coming in and rates high, it wasn't going to last.
"Another PM in the sector offered a more philosophical take: "every bubble gets its moment."The wider version of the trade, as Bloomberg reported on Oct 2, was the OAT asset-swap: funds such as Balyasny had built positions to harvest the spread between French yields and interest-rate swaps. Those were lucrative right up until the budget blowup of Oct 1, when the trades flipped from winners to liabilities and everyone hit the exit at once.
RBC BlueBay's Kaspar Hense told Bloomberg what that looked like from the inside:"Most typical hedge-fund strategies are in risk reduction mode. There have also been stop-loss levels triggered, partly on the steepener trades and now on long France trades." (emphasis ours) — Kaspar Hense, RBC BlueBay Asset Management, via BloombergFidelity International's fixed income CIO Marion Le Morhedec went further, estimating that hedge fund activity could explain roughly half of the recent moves in the French-German spread, pointing to particularly heavy Eurex activity.
Turns out the "liquidity providers" were also the liquidity takers.Regular readers will recall that we called this one in real time on the very first day of the month:it's been a while since we had a European sovereign debt crisis *FRANCE-GERMANY 10-YEAR YIELD SPREAD WIDENS 8BPS TO 135BPS France CDS widest in 13 years — zerohedge (@zerohedge) October 1, 2026...which was followed hours later by "Debt Crisis Back?
European Bond Markets Crash, CDS Explode Amid France Budget Panic Contagion" (Oct 1). By the next day, the OAT-Bund spread hit 154bps, the widest since 2011, and the deleveraging was in full swing.Same Trade, Same Crowd, Same Exit DoorThe most damning detail in the eFC piece: according to the liquidity-provider trader, many of the PMs who blew up this month had already blown up in March, on the same positions.
That was when the Iran war and the Hormuz shock triggered the first great European rates unwind, and when, per Bloomberg, multi-strats from Millennium to Balyasny to ExodusPoint gave back some or all of their year-to-date gains as crowded trades unwound.Seven months apart, the same book got carried out twice. Diversification at its finest.
"They've blown up twice on the same trades." Another trader observes that a lot of funds moved into the European fixed income space in the belief that it was easy money:"The whole European carry system is now being questioned."You can see both episodes in Goldman's own long-OAT/short-Bund rolling futures basket, which the bank's Systematic Trading Strategies desk circulated to clients: a steady grind higher for three years, a wobble in March, and then a near-vertical collapse that has wiped out roughly five years of gains as the basket fell from a February peak of ~104.
3 to ~99.2.Goldman's STS desk described the October contagion mechanism in that same note (available to pro subs here):OATs have come roaring back into market focus over the last month.
Where an unwind of popular rates positions following the latest ECB meeting (mostly steepeners), seemed to spread to wider carry trades in the rates space among a bid for volatility. A weak starting position for France with regards to debt and fiscal background and uncertainty into next year's election as well as challenging budget process didn't help. (emphasis ours) — Goldman Sachs STS, Tim Huiszoon, Oct 12Translation: the steepener crowd got stopped out first, then the losses bled into every other levered carry position on the same risk books.
Not a fundamental repricing so much as a margin call with a French accent.Allianz Trade agrees, noting in an Oct 9 report that speculative shorts, hedge-fund asset-swap unwinds and thin liquidity created a negative loop, with market depth more than 50% below normal:"The speed reflects a positioning shock, not a pure repricing of fundamentals. Long-term investors are sitting out ahead of the elections...
Fragmentation is far from 2012 or 2020 levels, but the ingredients are in place." (emphasis ours) — Allianz Trade, "Toasted, not burnt", Oct 9Note the second sentence: the real money that would normally buy the dip is sitting on its hands until the election. Which leaves...
nobody.The Plumbing Problem Nobody Wanted To Talk AboutIt's not just about P&L. Hedge funds have stepped in as the marginal provider of liquidity in European sovereigns precisely as central banks, pensions and banks stepped back.
Per Bank of France data cited by Reuters, French government debt accounts for roughly €100 billion of the €250 billion in euro-area sovereign bonds pledged as repo collateral. In other words, France is the euro repo market.So far the repo market itself has held up, but the risk is obvious: a further ratings cut narrows the pool of institutions able (or willing) to take OATs as collateral, which raises funding costs, which forces more selling.
Commerzbank flagged exactly this back in September after Fitch's downgrade:"...once a second agency downgrades to single-A, OAT repos may cheapen visibly, similar to BTPs, where more than half of bonds already trade above the depo rate." (emphasis ours) — Commerzbank, via MNI, Sep 16With Moody's reviewing France on Friday, that is not exactly a theoretical concern.
And as we noted when the sell-side spent a day insisting the OAT rout was "just positioning," the contagion had already jumped to the banks, with the selloff reactivating Europe's "doom loop" (Oct 7). Goldman's European financials desk is still hiding under the desk:"We are staying in risk off mode on banks (topics remains Euro sovereign crisis fear + Rates + Competition + Agentic, ie peak ROTE)... Appetite for French banks is very low given how long it will take to have some clarity.
" (emphasis ours) — Goldman Sachs EU Financials specialist sales, Oct 20"Overshot Fundamentals"... Sa