Brexit: Implications for Gilt and Bund yields – RBC CM

Research Team at RBC Capital Markets, suggests that with about one week to go to the UK’s EU referendum, polls have shifted and the odds of a ‘Leave’ vote have risen.

Key Quotes

“Markets have become nervous as a result. We draw on our earlier work and remain convinced that both markets would rally, but for different reasons. Gilts should rally due to expectations of Bank Rate cuts ‘towards zero’ and another round of QE coupled with a drop in inflation expectations. The UK CDS spread, however, would probably rise and Gilts might even underperform in ASW terms, however.

Bunds, are likely to be driven by a different force, namely a renewed flight to safety. We would expect a Brexit vote to reignite fears in the peripheral markets and trigger flows into Bunds. With German paper already trading on a hefty scarcity premium and the ECB’s QE programme bound to buy more Bunds in an ever small part of the curve, 10y and 30y Bund yields in particular should fall and ASW should widen further.

In the UK, the driver is likely to be front end yields with the 5y point most likely the best performer. In the Bund market, it is likely the 10y part of the curve. We would expect 10y Gilts to trade below 1% and forward SONIAs imply rate cuts to around 10bp. 10yBund yields could drop significantly and lastingly below 0%.”