Shock Waves Ripple Through Credit Markets After U.K. Brexit Vote

Updated on
Wheeler: European Banks Long on Liquidity for Brexit
  • Cost of protecting corporate bonds surged by most since 2008
  • Gauge of bank borrowing costs hit highest level since 2012

Shock waves reverberated through credit markets after the U.K. voted to quit the European Union.

Measures of risk for corporate bonds and money markets surged. The Markit iTraxx Europe Index of credit-default swaps insuring investment-grade corporate bonds rose by the most since 2008, according to prices compiled by Bloomberg. A gauge of where bank borrowing costs will be in the months ahead, known as the FRA/OIS spread, hit the most extreme level since 2012 and a key rate of the cost for banks to convert euro cash flows into dollars increased.

Britain’s decision took investors by surprise after financial markets had priced in a vote to remain in the 28-nation bloc and polls showed it was too close to call. The Bank of England said on Friday it will take all necessary steps to ensure stability, while central banks across the world pledged to take action as needed to avert any breakdown in financial-market liquidity. Prime Minister David Cameron said he will resign.

“The market was not prepared for this,” said Geraud Charpin, a portfolio manager at BlueBay Asset Management in London, which oversees $58 billion. “It’s come as a shock. People are scrambling.”

More than $19.7 billion of protection on the investment-grade benchmark changed hands on Friday, almost five times an average full day, Bloomberg data show. Traders have bought and sold $55 billion of swaps on the index so far this week.

The investment-grade derivatives index jumped 18 basis points to 92 basis points as of 3 p.m. in London, according to data compiled by Bloomberg. The three-month FRA/OIS spread widened to as much as 0.34 percentage point, from 0.27 on Thursday. The measure indicates where traders expect the gap between the three-month dollar London interbank offered rate, or Libor, and the Fed Funds Effective Rate -- dubbed Libor/OIS -- will be in the future.

The three-month euro-dollar cross-currency swap rate widened to 43 basis points below Euribor from a spread of minus 36 basis points on Thursday, the biggest increase since December 2015.

Bond Risk

In the U.S., the risk premium on the Markit CDX North America Investment Grade Index, a credit-default swaps benchmark tied to the debt of 125 investment-grade companies, jumped about 11 basis points to 87 basis points, the most since October 2014. A similar gauge for junk bonds surged 38 basis points to 460 basis points, the most since December 2015.

“It feels worse because of the pretty significant rally in risk assets we saw going into the vote,” said Dan Ivascyn, group chief investment officer of Pacific Investment Management Co., which manages $1.5 trillion. “Given the volatility, the markets will be unpredictable for the next several trading sessions.”

The Markit iTraxx Europe Senior Financial Index of credit-default swaps on banks and insurers climbed 30 basis points to 126 basis points, the biggest increase since July 2007, according to data compiled by Bloomberg. The subordinated benchmark rose 52 basis points to 257, the biggest jump since 2014, the data show. In the U.S., measures of default risk for Morgan Stanley and Goldman Sachs Group Inc. rose the most since August 2011.

Risky Debt

The riskiest bonds issued by some of Europe’s banks posted record declines, based on data compiled by Bloomberg. UniCredit SpA’s 1 billion euros of additional Tier 1 notes fell 7 cents to 77 cents, the biggest drop since 2014, while Deutsche Bank AG’s 1.75 billion euros of AT1s fell 4 cents to 79 cents. Barclays Plc’s 1.1 billion euros of 6.5 percent AT1 bonds fell 6 cents to 89 cents, Bloomberg data show.

Among the largest declines in high-yield bonds were notes sold by U.K. companies reliant on consumer spending. Debt from department-store operator Debenhams Plc and restaurant chain PizzaExpress Ltd. both fell 5 pence to 95 pence, the biggest declines since the two notes were sold in 2014.

“We’re expecting markets to overshoot downwards, so it will give opportunities for investors at some point,” said Francois Lavier, who oversees $3.4 billion of bank debt at Lazard Freres Gestion in Paris. “We’re waiting for what the central banks and governments will announce.”

ECB Purchases

Some investment-grade corporate bonds in euros rose amid expectations that the European Central Bank may step up a purchase program. Notes from companies including Veolia Environnement SA, Electricite de France SA and auto-parts market Robert Bosch GmbH increased more than two cents on the euro.

“The ECB’s corporate debt program will be used quite heavily today,” said Jonathan Pitkanen, the head of investment-grade research for EMEA and Asia at Columbia Threadneedle Investments, which oversees about $460 billion of assets. “They may even try to speed up the pace of buying to support the markets.”

The selloff started during Asian trading hours, with the Markit iTraxx Asia ex-Japan Index rising 10 basis points to 147 basis points, the biggest daily increase since March, according to data compiled to CMA.

“I ascribe the panicked look to markets this morning to Asia just not anticipating the possibility a Brexit vote could happen,” Bill Blain, a strategist at brokerage Mint Partners in London wrote in a note to investors. “Yesterday, they were told Remain were a sure-fire winner.”

Watch Next: Friday's Market Moves Could Have Been Worse, Says Nielsen

— With assistance by Luca Casiraghi, Tom Beardsworth, Joe Mayes, Liz McCormick, Sally Bakewell, and Katie Linsell

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