Article / 29 June 2016 at 10:30 GMT

Weekly Bond Update: Brexit blues

Fixed Income trader / Saxo Bank
  • Populist revolt won't end with Brexit vote
  • Mass dissatisfaction dates back to 2007-8
  • Fed rate hike placed firmly on ice

In the '90s, globalised liberal capitalism was held to be "the end of history";
in 2016, it looks just another beginning. Photo: iStock 

By Michael Boye

In an historic and sensational referendum vote, the British electorate upset the political establishment and opted to leave the European Union last week. The surprise decision has left the political system on both sides of the aisle in chaos, and caused panic in financial markets. 

For the latter, the reaction has undoubtedly been magnified by the fact that almost all bookmarkers and pundits (and reportedly even Boris Johnson as well) had virtually locked up the Britains to stay in the union right up until the moment when the very first results were announced.

Underpinning the surprise outcome is an overall disgust with politicians and the establishment as a whole. As such, the decision potentially carries a much wider impact for the political and economic future elsewhere in Europe, ahead of election cycles in Germany, France and quite possibly also Italy and now the United Kingdom as well (not to mention the US this November). 

This sentiment is stretching its roots all the way back to the aftermath of the financial crisis, where the taxpayer was asked to pick up the bill for the havoc primarily wreaked by greedy bankers on the loose and fueled by central banks and politicans, which to this very day remains evident in stubbornly low economic growth. 

Add to this the ongoing immigration crisis and ever stronger globalisation forces, which together are posing a greater and greater threat to the European welfare systems.

Political more than economic

While the political response is now subject to intense speculation (and uncertainty), which may not even result in the UK actually leaving the European Union, we still think there is a mutual interest in a peaceful solution that will leave the most important trade arrangements intact. 

The economic response from central banks, however, is all the more interesting from an investor's perspective. 

Already, the next rate hike from the Federal Reserve has been postponed indefinetely, as anticipated by investors, with a rate cut now priced at a higher chance at each of the next three policy meetings in Washington

Likewise, a rate hike by December is seen at less than a 1 in 10 chance (somewhat less surprising for our regular readers), and indeed may not happen in 2017 at all. 

In Europe we would expect both the Bank of England and European Central Bank, perhaps with the coordination of other global central banks, to ramp monetary policy efforts in an attempt to restore economic and financial confidence in the region. The United Kingom is now on the brink of recession and inflation as well as growth on the continent still refuse to leave rock bottom.

This should help keep government yields low for the foreseeable future, despite already stretched (and perhaps bubble like?) levels. In the end, we think risk sentiment will endure as well, although risk premiums (and volatility) could remain elevated for some time due to the increased political uncertainty across the vulnerable union. 

Pick up the risk premium in UK assets

For obvious reasons, UK assets have been at the eye of the storm and corporate bonds have been no exception. Financials and the equity-like subordinated debt instruments have seen particular pressure, and should thus represent the most obvious comeback candidates. 

However, non-financials such as Thomas Cook have seen their share of risk-aversion as well. 

We have compiled a list of some of the most active United Kingdom corporates, which you will find attached to this message.

City of London
Could certain UK assets be preparing to roar back to life? Photo: iStock 

— Edited by Michael McKenna

Michael Boye is a fixed income trader at Saxo Bank

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Brexit bonds


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