The knee-jerk reaction to Brexit in the credit markets is similar to that as seen in the equity markets but has been exacerbated by illiquidity and rising levels of bank stress.
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Bank of America credit analyst Barnaby Martin points out that since Thursday, Euro Investment Grade spreads are 14 basis points wider, Sterling Investment Grade spreads are 18 bps wider, and EUR high-yield spreads are 65 bps higher. Most of the reactions were in line with the bank’s initial knee-jerk reaction forecasts with the exception of Sterling Credit Spreads.
Indeed, Bank of America was initially predicting a widening of spreads of 30 bps to 40 bps in the event of Brexit. With spreads wider by only 18 bps at time of writing, credit analysts believe the spreads are still too tight to price the risk in effectively. Some other observations by Bank of America on the credit market:
“Of note: bonds have outperformed CDS (CSPP effect), Euro IG non-financials have outperformed banks (CSPP effect), AT1s have outperformed bank equities (search for income), corporate hybrids have significantly underperformed their senior debt, peripheral corporates have underperformed peripheral sovereigns (despite the Spanish election), and BBs (+49bp) have widened much more than BBBs (+18bp) would imply.â€Â — Bank of America
So far, the reaction to Brexit in the credit markets has been relatively subdued, considering some analysts are going so far as to call this the next Lehman event. There is no denying that the situation could become a lot worse for credit investors. BoA speculates that the most important barometer for credit investors is bank shares. European banking equities are being hit hard in recent days and if they keep falling, as history has shown, it can lead to tighter credit conditions, exacerbating the Eurozone growth slowed down, which would lead to greater deflationary pressure bolstering the “quantitative failure†narrative, risking a more systemic sell-off.
