Myriad of Brexit Scenarios to Shock Investors in U.K.'s Bonds

(Bloomberg) -- Gilt traders face a raft of Brexit outcomes over the next four months that may jolt yields out of this year’s range.

BNP Paribas SA sees six potential scenarios ahead of next week’s vote on Prime Minister Theresa May’s deal to leave the European Union. While a rejection would send benchmark gilts yields from about 1.29 percent now to below 1 percent, they could climb to 1.7 percent if lawmakers pass her agreement, the bank said.

Scenario 1: Deal reached, yields surge

  • Market impact: 10-year yield rises to 1.7 percent, two-year rises from 0.71 percent now to 1 percent by March 2019
  • “Fading uncertainty and increased expectations of further normalization of BOE monetary policy, alongside rising global yields, should push U.K. yields significantly higher,” writes BNP strategist Parisha Saimbi
  • Base case is for a deal to be struck eventually, with a 50 percent probability

Scenario 2a: Rejected with narrow majority, yields slip

  • Market impact: 10-year yield slips to 1.3 percent, two-year to 0.7 percent
  • “Sentiment would be likely to be negative in the short term, as uncertainty persists for longer”
    • “However, the real implications for markets would probably depend on how the renegotiations proceed and on clearer indications of whether the likely outcome will be a deal, no deal or extension of Article 50”

Scenario 2b: Rejected with large majority, yield falls

  • Market impact: 10-year yield falls to 1.2 percent, two-year to 0.6 percent
  • “While it is possible that Parliament passes a deal on a second vote, the bottom line in this scenario would be, in our view, that uncertainty would persist for longer, weighing on investment”
    • “If Article 50 is extended, then the Bank of England might hike later than our central case of May”

Scenario 3: No deal, yields tumble

  • Market impact: 10-year yield slides to 1 percent, two-year to 0.2 percent by March 2019
    • German 10-year yield falls to 0.15 percent, Italy-Germany yield spread blows out to 375 basis points
  • “We would expect rate hikes to be priced out and uncertainty to build. This move would be likely to extend towards 0.80 percent as economic data and confidence indicators weakened sharply, prompting easing by the BOE”
  • Sees a 30 percent chance of a no-deal outcome

Scenario 4: Second referendum, yields rise

  • Market impact: 10-year yield rises to 1.5 percent, 2-year to 0.75 percent by March 2019
  • “We would expect a softer Brexit outcome to be priced in, given that the potential referendum outcomes would be skewed toward a closer EU relationship, including a ‘no-Brexit’ scenario, seeing yields rise significantly from the levels in scenario 2b”
  • Sees a 20 percent chance of no Brexit

Scenario 5: Early general election, yields climb

  • Market impact: 10-year yield climbs to 1.6 percent, 2-year to 0.85 percent
  • “With yields already having likely shifted lower (see scenario 2b), we would expect the prospect of a Labour-led government to prove quite negative for gilts, particularly at the long end”

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