EU Referendum – The Impact on Fixed Interest Markets

July 12th, 2016, by Georgina Ogilvie-Jones

The first two weeks after the EU vote saw further sharp moves within bond and currency markets driven by the continued fallout from the UK EU referendum. Sterling is now at 1.29 to the dollar, having hit a 31-year low on 5 July. Yields on US treasuries, the benchmark for bonds worldwide, hit record lows out to 30 years duration. The benchmark 10-year bond offers just 1.40% in yield, compared to 2.3% at the beginning of the year and 4% at the end of 2007 before the credit crisis and the onset of extraordinary monetary policy.

UK 10-year gilt yields went below 1% for the first time in history in June and are now at 0.73% (6 July). Extraordinary effects have also been seen in European bonds with peripheral bond yields increasing, for instance 10-year Greek benchmark bonds are yielding 7.7% and for the equivalent Portuguese bonds the yield is 3%. On the other hand the perceived safety of German Bunds was enhanced leading to further price rises and declining yields with the 10-year benchmark bond moving into negative territory once again with a yield of -0.2%.

There is an inverse relationship between the price of a bond and its yield. These historically low yields have all been accompanied by significant price rises for sovereign bonds. The situation was fuelled initially by quantitative easing operations by the major central banks following the credit crisis and has been exacerbated since the referendum by investors seeking the perceived safety of sovereign bonds issued by major developed world borrowers. This is a situation that we find paradoxical when so many bonds are seriously overvalued and are offering either very low or negative yields creating the potential for irrecoverable capital losses. The chart below shows the significant decline in government bond yields for a number of major sovereign issuers between 2006 and 2016.

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