Daily Insight
Group Economics Macro & Financial Markets Research
29 June 2016
Is Brexit risk now priced in? Macro & Financial Markets Research team Tel: +31 20 343 5616 nick.kounis@nl.abnamro.com
Global Markets - After two days of turmoil, financial market tensions eased on Tuesday for the first time since the UK's vote for Brexit. Investor sentiment turned, with equities and commodities rising and sterling strengthening. What explains the improvement? There was some speculation that investors were buoyed by the idea that central banks would come to the rescue with easier monetary policy. Maybe. Though it seems that there was little fresh news on this compared to Friday or Monday. Another possibility is that much of the perspective weakness in economic growth and some of the downside risks have now been priced in. This is a possibility, though only assuming that Brexit does not morph into a fullblown euro crisis with wider contagion. It is too early obviously to be sure of this or how investors perceive these risks. Indeed more generally, it is too early to speak of a change in trend. We could just be witnessing a 'dead cat bounce' or a pause for breath on the way down. This is probably the case for sterling, which looks to need to correct further given the risks related to the UK's huge current account deficit and the capital flows necessary to fund it as well as the cushion the UK economy will need. (Nick Kounis) Government bonds - The German government announced that its funding requirements for the third quarter of 2016 will decline for both its conventional bond and inflation-linked programme. For its conventional programme, the issuance of 12-month T-bill paper will be reduced by EUR 1bn to EUR 2bn. The scheduled issuance volume of inflation-linked bonds for the whole of 2016 will drop to between EUR 6 to 10bn, while previously the target was set at EUR 8 to 12bn. Since the German funding arm already issued EUR 4.5bn of inflationlinked bonds in the first 6 months, this means that linker supply in the second half of the year will be limited. The decline in borrowing need is good news for the German government but it’s bad news for the ECB. German sovereign bonds take up a significant part of the purchases under the ECB’s QE programme. As supply will drop and as yields have dropped to historical low levels, the pressure is mounting for the ECB to find enough eligible bonds. According to our calculations, we think that the issuer share limit (now set at 33%) for German bonds will be hit before the soft QE end date of March 2017. This means that the ECB will need to change its purchasing rules or hope that yields move higher, which increases the pool of bonds which are eligible for purchases. (Kim Liu) Italian banks - The Italian government seems to have seized on the Brexit crisis to convince Brussels (and hawkish member states such as Germany) that they should be allowed to give their banks state aid and hence circumvent the bail-in rules. Reports suggest the government wans to provide EUR 40bn in the shape of guarantees to help to recapitalise the sector. This is a fraction of the EUR 360bn NPL amount but enough to significantly boost capital to provide some buffer for the problem. The NPL issue in Italy is chronic, a number of banks are undercapitalised and investor appetite for cash calls has become almost non-existent. The European Commission has made it clear that only in ‘very extraordinary systemic stress’ that state aid can be allowed, but crucially only when shareholders and institutional creditors have taken full losses. We therefore do not believe state aid can be given within the current laws, as then all investors would be penniless. We therefore maintain our negative view on Italian bank debt. (Tom Kinmonth)
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Bloomberg: ABNM
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Daily Insight - Is Brexit risk now priced in? - 29 June 2016
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Daily Insight - Is Brexit risk now priced in? - 29 June 2016