HALISTER1: RESEARCH ROUNDUP: How Likely Brexit Is And How Do to Trade It

RESEARCH ROUNDUP: How Likely Brexit Is And How Do to Trade It

(Bloomberg) -- With one month to go until the U.K. vote on EU membership, market pricing is relatively sanguine as a flurry of polls show the remain camp is firmly in the lead and betting odds for remain are at their shortest yet.
  • Nomura sees the likelihood of a Brexit at 25% while SocGen puts the probability at 45%
  • GBP/USD 1-mo. vol is at 11.2, highest since Feb. 29
  • Short-sterling markets price a BOE rate cut, which RBS says reflects uncertainty about the June 23 vote. Barclays analysts say a vote for Brexit could see rates cut possibly to zero while Morgan Stanley expects cut to 10 bps; both say QE may resume
  • Favored trades include selling sterling, periphery EGBs 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 April 19 note
    • A hypothetical exit would lead to a marked slowdown in activity in 2H 2016 and 2017 with average quarterly growth dropping to -0.1% in 2H and GDP contracting by 0.4% in 2017
    • BOE may cut rates by 50bps and could extend QE by GBP100b to GBP150b
    • Remain cautious on peripheral spreads, will find it difficult to tighten meaningfully given risks associated with the EU referendum, domestic political issues
  • RBS
    • 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; referendum is one of 4 global risk events taking place over 11 days, strategist Simon Peck writes in May 20 note; the others are the BOJ meeting, Spain elections and the next ECB TLTRO
    • If the U.K. votes to remain in the EU, 10Y BTP/bunds may tighten by 60bps to 70bps very quickly
    • July, August SONIA look good value as Brexit is 6% discounted in July whereas it officially should be 50%
    • Favor longs 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 and trade to hit growth on a vote to leave, with a fall in GBP pushing inflation above target; BOE may cut to 10bps and do another GBP50b of QE if leave led to recession
    • U.K. and European equities could fall by 15%-20% in the event of Brexit, albeit not necessarily in one immediate hit, analysts say in May 5 note
    • Maintain long 10Y Gilts vs 5Y USTs; lack of premium in price given Brexit concerns, analysts including Anton Heese write in May 20 research note
    • 10Y Gilt to perform ok in a “remain” scenario, outperform significantly on risk off should there be a vote to leave
  • BofAML
    • 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 GBP weakness headed into the referendum, after seasonal outperformance in April, analysts write in May 20 note; GBP/USD is vulnerable to further losses as it was ahead of 2015 election
    • Favor short gilts vs bunds both as a trade working in a Brexit scenario and on diverging supply dynamics; keep front end steepener in GBP swaps vs flattener in EUR swaps
  • SocGen
    • See risk of Brexit at 45%; Brexit would hit growth by 0.5% to 1% for 10 years, analysts including Brian Hilliard write in March 10 note
    • Would see GBP/USD trading below 1.30, and EUR/USD below parity
    • Risks of Brexit have diminished according to betting odds, polls but the 4y1y/5y1y/6y1y fly remains close to lows even as front end has steepened; 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
      • GBP would have to fall by 30% to make a rate cut look unlikely, writes in May 23
    • Expect a further 10% drop in GBP following a leave vote, pushing inflation to close to 3% by end-2017; Taylor rule analysis suggests BOE cutting rates to zero isn’t unreasonable
    • Turn neutral on duration, take profit on long 10Y Gilts vs USTs as markets re-price Brexit risk, strategists including Fabio Bassi write May 20
    • Vote to stay won’t necessarily leave PM Cameron in authoritative control of his own party, Malcolm Barr writes in May 11 note
    • If Brexit happens, favor exporters over domestic, and FTSE 100 vs FTSE 250, JPMorgan equity strategists including Mislav Matejka and Emmanuel Cau write in April 25 note
  • Nomura
    • Around a 25% likelihood 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, MPC may bring Bank Rate to slightly negative before restarting QE although that’s not a foregone conclusion
    • If poor market functioning facilitated a GBP collapse far beyond the 10%-15% trade-weighted fall Nomura expects, BOE intervention not out of the question; efficacy 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; a key market event may prove to be televised debate on 21 June
    • The economy may not bounce back in 2H on a remain vote; expect an immediate, simultaneous economic and financial shock on a vote to leave
    • Buy USD/SEK 2-mo. 8.6372 strike 15d call to hedge for Brexit, a EUR/USD 2-mo. 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% to 4% decline in GDP over a 2 to 3-year timeframe
    • BOE cutting rates toward zero and the potential for further QE gilt purchases would lead to lower gilt yields
    • GBP could fall 10%-15%
    • Favor trading GBP tactically; dominant risk is that implied probability of exit risk rises, FX strategists say in May 6 research
  • Deutsche Bank
    • In baseline view that the U.K. stays, expect economy to grow at around 2-1/4% 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
    • GBP may bounce on a remain vote, downside risk to economy suggesting selling sterling, analysts write in May 20 note
      • Favor buying 9-mo. GBP/USD put, shorting GBP TWI
  • HSBC
    • Central case is U.K. votes to remain in the EU
    • Push back forecast for first rate rise to May 2017 from Nov. 2016 and cut GDP forecasts for 2016 to 1.8% vs 1.9% and for 2017 to 2.1% vs 2.2%, Simon Wells writes in note dated May 16
    • If U.K. votes to leave, BOE cutting rates can’t be ruled out, but isn’t HSBC’s central case
    • Expect gilt yields to head lower and favor 5Y to 10Y segment of the curve; 2Y to 5Y segment to flatten, Bert Lourenco says in May 12 note
    • Could mean a 15%-20% fall in sterling and a 1pp-1.5pp slowdown in growth, writes in Feb note
  • UBS
    • Expect markets to price in confrontational negotiations between the EU and the U.K. if it votes to leave; GBP would be most vulnerable, analysts Nishay Patel and John Wraith write in May 22 note
      • Expect 10Y Italy-Germany spreads to widen to above 175bps, Ireland-Germany to over 90bps and Spain to underperform Italy ** If the U.K. votes to stay, peripheral spreads may tighten vs Germany and sterling may appreciate over the remainder of the year
  • Goldman Sachs
    • Don’t favor playing GBP vs EUR to express a view on a possible exit as wouldn’t be good news for rest of Europe either; not inconceivable for investors to sell euro-area assets as a result, Goldman Sachs strategist Silvia Ardagna writes in April 4 note
    • If U.K. remains in EU, FX market would have to price a more hawkish BOE, and an earlier start and faster pace in tightening than discounted in forwards; expect 15% upside in GBP over 12 mos. in this instance
Alert: HALISTER1
Source: BFW (Bloomberg First Word)

People
Allan Monks (JP Morgan Chase)
Anton Heese (Morgan Stanley)
Bert Lourenco (HSBC Securities Inc)
Brian Hilliard (Societe Generale SA)
Emmanuel Cau (JP Morgan Securities PLC)

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