Wall Street History

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Wall Street History

09/16/2016

The Action in the Bond Pits, Post-Brexit

Following is an update on the euro bond market, post-Brexit, as the region grapples with the uncertainty of Britain leaving the European Union, the monetary policies of the European Central Bank (and others of its ilk around the world), and the politics of the region.

But despite the volatility in the fixed income sector, overall, the markets have remained fairly stable.

I note 6/23 and 6/24 because this is the ‘before’ and ‘after’ Brexit.  June 23rd was the Thursday of the referendum for leaving or remaining in the EU for British voters and that day, the feeling was they would elect to stay, with yields rising in the days before in the likes of Germany, France and the U.K., while they had been falling in the periphery countries that were seen benefiting from ongoing QE, or the ECB’s quantitative easing program.

But that evening the vote rolled in and it was a shocker.  The Leave camp had won out over Remain.  So the next day you had a total reversal of the trade, a flight to quality, with the yields in Germany, the U.K. and France plummeting, while that of the periphery (Italy, Spain and Portugal) rose.  [Greece did as well, but it’s a special case. The ECB isn’t buying its sovereign paper until it’s satisfied it has a viable debt reduction plan.]

So what has happened since June 24, after the initial shock wore off?  Quality has still won out as central banks continued to add monetary stimulus, but then the last few weeks, markets have begun to question central bank actions around the world, and the issue of whether the focus will switch from monetary to fiscal policy as authorities finally see the limits of historically low interest rates, if not outright negative ones.

For example, the British 10-year’s yield has risen from 0.56% on 8/26 to 0.87% on 9/14; in Italy from 1.13% to 1.29% over the same period.  [In the U.S. from 1.54% to 1.69%.]

The U.S. Federal Reserve meets next week, Sept. 20-21, and this has compounded the uncertainty as Fed officials grapple over the timing of the next rate hike...now or in December?

IF bond markets around the world ever truly believed that central banks would embark on a policy of more normalized rates instead of the extraordinary moves they’ve been taking for years, the carnage in some bond markets will be substantial.  But I’ve been wrong in this regard for years.  Someday, though, I’ll be right.

10-yr yields...6/23...6/24...9/14

U.K. ... 1.37% ... 1.08% ... 0.87%

Germany... 0.09 ... -0.05 ... 0.02

France... 0.45 ... 0.38 ... 0.31

Italy... 1.39 ... 1.55 ... 1.29

Spain... 1.46 ... 1.62 ... 1.07

Portugal... 3.06 ... 3.30 ... 3.24

Greece... 7.54 ... 8.31 ... 8.32

U.S. ... 1.74 ... 1.58 ... 1.69

Wall Street History will return in two weeks.

Brian Trumbore

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