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Will the U.K. Vote Against Europe? Markets Vote No

Matthew A. Winkler is a Bloomberg View columnist. He is the editor-in-chief emeritus of Bloomberg News.
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A week before Britain votes on whether to leave the European Union, polls show that the public's preference is too close to call. Financial markets provide a different view: a persistent expectation that the U.K. will remain. When markets and polls point in different directions, markets tend to be superior prognosticators.

QuickTake Will Britain Leave the EU?

That's not to say that markets don't reflect the heightened anxiety associated with the uncertainty of a major election. Investors can’t ignore warnings from authorities such as Germany's Finance Minister Wolfgang Schaeuble, who raises the specter of a calamity, and former U.S. Treasury Secretary Larry Summers, who’s predicting a U.K. recession caused by a British split from Europe.

The U.K. pound is now the world’s riskiest currency to invest in, as measured by traders' bets on the magnitude of the currency's price swings during a period of 30 days. That one-month implied volatility metric recently surged the most since the financial crisis of 2008. It topped the 31 most-traded currencies, meaning that the pound is perceived right now to be more treacherous than the Russian ruble, South African rand and Brazilian real, according to data compiled by Bloomberg.

If traders expected Britain to exit the European Union, they would be betting on continued turbulence for the pound and other assets.

They aren't. While one-month volatility was soaring, one-year volatility was little changed or flat, according to data compiled by Bloomberg.

Short-Term Turmoil, Long-Term Calm

Bloomberg

The stock market shows a similar expectation. Both one-year and one-month implied-volatility measures of the FTSE 100 Index have been declining since the beginning of the year, suggesting that global investors don't anticipate significant fluctuations in the value of their shares, according to Bloomberg data. Even more compelling is the rising premium of the FTSE 100 compared with its European benchmark, the EURO STOXX 50 Index, on a forward-looking earnings basis. The average premium is 20 percent this year, the highest since at least 2005, when Bloomberg began compiling such data.

In the market for British government securities, fears associated with Brexit or any other threat are diminishing. After peaking in April, U.K. credit default swaps, which are the equivalent of insurance policies against the loss of value of government bonds, are down 27 percent from their worst (highest) price of 2013. The yield on the benchmark U.K. government bond, the 10-year gilt, fell to 1.144 percent, the lowest since 1992, when Bloomberg began compiling such data.

The U.K., with its referendum scheduled for June 23, isn’t the first country preparing to vote on an issue related to national sovereignty with polls and markets diverging. In at least three other cases, markets have turned out to be more reliable.

During the weeks preceding Quebec's 1995 plebiscite over secession from Canada and Scotland's 2014 vote on independence from the U.K., there was a similar dichotomy, with markets signaling no breakup.

At this point last year, the world was dominated by headlines and commentary predicting Greece's default and exit from the euro currency it shares with 23 countries, including Vatican City. The market for Greek government debt belied both of these outcomes as the yield on the benchmark 10-year government bond never approached its peak of almost 30 percent in 2012 -- flirting briefly with 19 percent in July before rallying to less than half that yield. Greek bonds proved to be the world's best-performing asset in 2015.

In the final weeks before the Quebec referendum in October 21 years ago, the Canadian dollar's one-month volatility was the highest since 1988, signaling an economic crisis. It never came, of course, and the people of Quebec remain Canadians.

The markets say that with Brexit, this time isn't different.

(With assistance from Shin Pei)

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Matthew Winkler at mwinkler@bloomberg.net

To contact the editor responsible for this story:
Jonathan Landman at jlandman4@bloomberg.net