Article / 22 June 2016 at 11:00 GMT

Weekly Bond Update: Brexit could be a buying opportunity

Fixed Income trader / Saxo Bank
  • Polls often get independence votes quite wrong
  • Markets starting to expect a Remain consensus
  • Brexit could still provide a buying opportunity

Last year's London: It is beginning to seem as if EU crises 
are becoming something of a summer ritual. Photo: iStock 

By Michael Boye

It's another summer and another European Union-related drama, it seems. With the Greek debt saga of last year still a fresh memory, this summer sees a similar swirl of sentiment with the anticipated outcome of the June 23 Brexit vote. 

(As we write these lines, though, optimism has begun to take the day as momentum has swung back in favor of the "Bremain" campaign...)

One interesting observation that could be supporting this move is that, in spite of opinion polls still largely revealing coin-toss odds, the history of independence referenda results shows more support for the status quo vote (Remain, in this case) than opinion polls anticipated.

In this chart, courtesy of Deutsche Bank, we can see this to be true to the tune of about 5% for both Scotland's independence vote in 2014 and Quebec's referendum in 1995 (granted, the sample size is rather small for these sorts of things).

 Source: Deutsche Bank

Should the British electorate, however, decide upon a shock departure from the EU, the fixed income asset classes most at risk, in our view, would be peripheral spreads and European high-yield credit as the uncertainty over the future of the union (as well as independence movements in other areas) would boost risk premiums.

Taking a quick glimpse beyond the short-term panic, however, we think a Brexit decision could bring a long-term buying opportunity across risky assets in Europe. The specific impact of a Brexit remains uncertain, and uncertainty – as we know – is no friend of financial markets.

Perhaps this, then, is the biggest factor behind all the nervousness. 

In reality, and regardless of the outcome of the vote, there will be no definitive change come Friday morning. In case of a Leave vote, political negotiations would ensue between Great Britain and the rest of the EU to settle the conditions of the relationship. 

We believe a peaceful solution with largely unchanged conditions on the most important trade and harmonisation parameters is highly likely. Both parties are highly interdependent from an economic perspective (consider, for example, German carmakers and their all-but-certain push to retain access to the UK market). 

Beyond trade integration, the legal harmonisation between the UK and EU is already quite significant after three decades of membership, allowing the transition to be more seamless and increasing the odds for a Norway- or Switzerland-style deal to be struck. 

The Leave campaign has even been claiming that an independent UK's ability to seek trade deals with the US and China will prove greater than the unified approach that has proved fairly fruitless so far.

If the British electorate decides to make what looks like a nearly unprecedented choice Thursday, there almost certainly will be blood in the streets come Friday morning. Ultimately, however, we think investors would then wise to remember Buffett's famous maxim: be greedy when others are fearful, and vice versa!

If not blood in the streets, then at least some dramatic cloud cover. 
Some sort of visual sign, at the very least. Photo: iStock

— Edited by Michael McKenna

Michael Boye is a fixed income trader at Saxo Bank


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