With just under a month to go until the U.K. vote on EU membership, investors are relatively sanguine as a flurry of polls show the remain camp firmly in the lead and betting odds for the U.K. staying in the trade bloc are at their shortest yet.
Analysts at Nomura see the likelihood of a Brexit at 25 percent while Societe Generale economists put the probability as high as 45 percent.
Short-sterling markets price the possibility the Bank of England’s next move may be a rate cut, a sign there’s still uncertainty about the June 23 vote outcome, according to analysts at the Royal Bank of Scotland Group PLC. Barclays PLC analysts say a vote for Brexit could see rates cut, possibly to zero, while Morgan Stanley expects a cut to 10 basis points under this scenario. Both say quantitative easing could resume.
Favored trades include selling sterling, peripheral European government bonds and FTSE 250 stocks.
Barclays
Baseline scenario is that the U.K. doesn’t leave the EU. Uncertainty is likely to weigh on investment and consumption, analysts write in a note dated April 19. A hypothetical exit would lead to a marked slowdown in activity in the second half of 2016 and in 2017 with average quarterly growth dropping to -0.1 percent in the second half and gross domestic product contracting by 0.4 percent in 2017.
Bank of England may cut rates by 50 basis points and could extend QE by another 100 billion to 150 billion pounds.
Remain cautious on peripheral spreads, which will find it difficult to tighten meaningfully given risks associated with the EU referendum and domestic political issues.
RBS
The MPC-dated SONIA strip suggests policy easing expectations revolve largely around a “leave” vote with the lowest point in the curve in autumn 2016, unwinding steadily thereafter, economist Ross Walker writes in note dated May 18.
Expect liquidity to dry up in coming weeks. The referendum is one of four global risk events taking place over 11 days in June, strategist Simon Peck writes in May 20 note. The others are the Bank of Japan meeting, Spanish elections and the European Central Bank’s next targeted long-term loans operation. If the U.K. votes to remain in the EU, the spread between 10-year Italian bonds against German bunds may quickly tighten by 60 to 70 basis points.
July and August dated SONIA look good value as Brexit is 6 percent discounted in July whereas it officially should be 50 percent. This favors long positions in safe haven bonds, which appear very underpriced for some outcomes in the upcoming events.
Morgan Stanley
Expect a gradual pick up in domestic inflation, leading to rate rises from early 2017 on a remain vote, analysts write in May 5 research note.
Uncertainty over the government, Scotland’s stance and trade will hit growth on a vote to leave, with a fall in the pound pushing inflation above target. BOE may cut the bank rate to 10 basis points and do another 50 billion of QE if a vote to leave leads to recession
U.K. and European equities could fall by 15-20 percent in the event of Brexit, albeit not necessarily in one immediate hit
Given the lack of Brexit-related premium in the price of 10Y gilts, maintain long vs 10Y Treasuries, analysts including Anton Heese write in May 20 research note. 10-year gilts are expected to perform ok in a “remain” scenario and to outperform significantly on risk off should there be a vote to leave, Heese says.
Bank of America Merrill Lynch
Polls suggest a remain vote is increasingly likely, Robert Wood writes in May 20 note; underlying economy is slowing and BOE’s latest forecasts suggest risks of rate cuts even in a “remain” scenario are rising.
Expect renewed period of pound weakness heading into the referendum, after seasonal outperformance in April, analysts write in May 20 note. The pound is vulnerable to further losses. as it was ahead of 2015 election. Favor shorting gilts versus bunds both as a trade working in a Brexit scenario and on diverging supply dynamics; keep front-end steepener in sterling swaps against flattener in euro swaps.
Societe Generale
See risk of Brexit at 45 percent. Brexit would hit growth by 0.5-1 percent for 10 years, analysts including Brian Hilliard write in March 10 note. The pound could trade below $1.30 and the euro could drop below parity against the dollar.
Risks of Brexit have diminished according to betting odds and the polls, but the 4y1y/5y1y/6y1y fly remains close to lows even as the front end has steepened. There’s potential for a return to levels seen in February and in 2015, Jason Simpson writes in May 20 note.
JPMorgan
The extent to which U.K. activity data is weakening ahead of the referendum will be an important factor for BOE policy decisions, whatever the outcome of the vote, analyst Allan Monks writes in May 20 note.
Expect a further 10 percent drop in the pound following a vote to leave, pushing inflation to close to 3 percent by the end of 2017. Taylor rule analysis suggests BOE cutting rates to zero isn’t unreasonable. The pound would have to fall by 30 percent to make a rate cut look unlikely if the U.K. voted to leave, Monks writes on May 23.
Vote to stay won’t necessarily leave prime minister David Cameron in authoritative control of his own party, Malcolm Barr writes in May 11 note.
Turn neutral on duration, take profit on long 10-year Gilts against USTs as markets re-price Brexit risk, strategists including Fabio Bassi write May 20. If Brexit happens, favor exporters over domestic corporates, and FTSE 100 against FTSE 250, JPMorgan equity strategists including Mislav Matejka and Emmanuel Cau write in April 25 note.
Nomura
See around a 25 percent likelihood the U.K. votes to leave the EU, analysts say in May 11 note. Most likely policy response will be for MPC to cut rates on any signs real economic data are deteriorating. If that’s sustained, the MPC may bring the Bank Rate to slightly negative before restarting QE although that’s not a foregone conclusion.
If poor market functioning facilitated a pound collapse far beyond the 10-15 percent trade-weighted fall Nomura expects, BOE intervention won’t be out of the question. Its efficacy though would be questioned by the markets. Expect significant curve steepening in a Brexit scenario.
Credit Suisse
Expect the U.K. to vote to stay, analysts including Neville Hall write in May 19 research note. The televised debate on June 21 may prove to be key.
The economy may not bounce back in the second half on a remain vote. Expect an immediate, simultaneous economic and financial shock on a vote to leave.
Buy USD/SEK 2-month 8.6372 strike 15d call to hedge for Brexit, a EUR/USD 2-month 1.1669 strike 25d call for a “remain” vote. Favor long FTSE 100 vs FTSE 250 in stocks.
RBC
Market-implied measures of Brexit risk indicate a “remain” is more likely, Sam Hill says in May 18 client note.
In a Brexit scenario, the uncertainty surrounding options for U.K.-EU relations may lead to a 2 percent to 4 percent decline in GDP over a 2-year to 3-year timeframe.
BOE cutting rates toward zero and the potential for further QE gilt purchases would lead to lower gilt yields. The pound could fall 10-15 percent. Favor trading the pound tactically. The dominant risk is that implied probability of exit risk rises, currency strategists say in May 6 research.
Deutsche Bank
In baseline view the U.K. stays, expect economy to grow at around 2 1/4 per cent this year and next. BOE may raise rates before end 2016, economist George Buckley writes in client on April 4. Brexit would be highly damaging for the economy.
The pound may bounce on a remain vote but downside risk to economy suggests selling the currency, analysts write in May 20 note. Favor buying 9-month GBP/USD put, shorting GBP TWI.
HSBC
Central case is U.K. votes to remain in the EU.
Forecast for first rate rise pushed back to May 2017 from Nov. 2016 and GDP forecasts for 2016 lowered to 1.8% vs 1.9% and for 2017 to 2.1% vs 2.2%, Simon Wells writes in note dated May 16. If the U.K. votes to leave, BOE cutting rates can’t be ruled out, but this isn’t HSBC’s central case.
Expect gilt yields to head lower and favor 5-year to 10-year segment of the curve; 2 to 5-year segment to flatten, Bert Lourenco says in May 12 note.
UBS
Expect markets to price in confrontational negotiations between the EU and the U.K. if it votes to leave. The pound would be most vulnerable, analysts Nishay Patel and John Wraith write in May 22 note.
See 10-year Italy-Germany spreads widening to above 175 basis points, Ireland-Germany to over 90 basis points and Spain to underperform Italy.
If the U.K. votes to stay, peripheral spreads may tighten vs Germany and the pound may appreciate over the remainder of the year.
Goldman Sachs
Don’t favor playing the pound against the euro to express a view on a possible exit as it wouldn’t be good news for the rest of Europe either. It’s not inconceivable for investors to sell euro-area assets as a result, strategist Silvia Ardagna writes in April 4 note.
If the U.K. remains in EU, the currency market would have to price a more hawkish BOE, and an earlier start and faster pace in tightening than discounted in forwards. Expect 15 percent upside in the pound over 12 months in this instance.
by Deborah Hyde
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