European politics weigh on uncertainty

Mark Dowding, partner & co-head of Investment Grade Debt at BlueBay Asset Management, gives his latest view on the markets.

Volatility has continued to decline in the last week.

Equity markets have moved higher and credit spreads have tightened modestly. Despite the constructive tone in risky assets, it has been reassuring to note that core government bond yields have been remarkably well behaved.

US yields were unchanged over the week, but in Europe, the yield curve has continued to move lower with 10yr bunds declining by 5bps and 30yr maturities performing even better. Perhaps the most significant development was the announcement last weekend of the date for the British referendum on Euro membership, 23 June 2016.

The starting gun for the Brexit campaign has been officially fired and there was immediately a flurry of activity as various politicians lined up on either side of the fence. Boris Johnson’s decision to join the “out” camp generated the most news and for us is significant.

Boris is a very big personality. Given his perceived bumbling and often comic demeanour, Johnson could be underestimated as a political operative. At this point, the polling is inconclusive, and we are loathed to make any grand predictions as to the final outcome of the vote.

What we can say with some certainty is that Brexit IS a big deal, both for the UK and for the EU in general and the event is going to generate a significant amount of volatility in financial markets. We have been running a modest short position in GBP against the US dollar, which has moved by more than 3% since the start of the week.

Looking ahead, we are somewhat sceptical that the hiatus in volatility can last. We continue to highlight the ECB meeting on the 10th of March as an important market event and believe the market is low balling what Mario Draghi delivers.

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