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Brexit: fixed-income markets push their anticipations back, we disagree

04 July 2016

Brexit stress did not last for long, to say the least.

After 2 days of rout, equity markets soared with US indices now back to their highs, UK indices are at their 2016 peak level (with a little help from GBP collapse) and Euro area equities recovered half of their losses.

The impact is much stronger on fixed income assets with a collapse in core bond yields, but also for EM and even peripheral yields – even though many were expecting these bonds to suffer in case of Brexit. Obviously, central banks are pushing yields lower, but price action shows clearly investors’ appetence for carry is stronger every day.

Our opinion on Brexit has not moved since last week: it is going to be a lengthy story, and we are not 100% sure to see UK exiting European Union in the end. Markets will carry on moving with central banks and macroeconomic statistics.

On the one hand, US equities are back to their highs, implying the Brexit impact on global and US GDP will be small, and on the other hand, US fixed-income markets see the next Fed hike not before 2018.

Current atmosphere is still favorable to EM assets, periphery bonds and carry assets in general. 

However, with these days’ bounce, equity indices upside potential seems limited to us. Euro area equities and Euro banks are lagging and are cheap, but the underlying fundamental dynamic is not great with lower earnings and flatter yield curves in Eurozone. 

Lastly, the European Central Bank will probably amend its Quantitative Easing rules in the coming months. Indeed, with the very strong rally over the last few days, and considering its current rules, it will be prevented to buy German bonds as early as August. There are several possibilities for the ECB: either it sets the limit from 33% to 50% percentage ownership of an issue. Or they can  expand to non CAC bonds, or amend the capital key.

The two former options will push forward the deadline by a few more months, so there is a decent chance markets will speculate in the coming months about a change in the capital key. This would be very favorable for peripheral spreads.

La Française’s Essentiel Markets brings you an insightful analysis of the latest financial news by François Rimeu, Head of Total Return at La Française Asset Management.

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