As Corbyn Enters Center Stage, Bonds May Price a Brexit Election

(Bloomberg) -- As Jeremy Corbyn gets invited to help resolve the Brexit chaos, the gilt market may return its focus to the tail risk of the Labour Party leader coming to power.

The fiscal uncertainty associated with the likely higher spending of any Corbyn led-government does not appear to be priced into the U.K. bond market. Prime Minister Theresa May’s gamble to deliver Brexit by seeking Corbyn’s assistance threatens to split her Conservative Party, with any increased signs of an election likely to steepen the longer-end of the gilt curve.

• A radical change in fiscal policy by a left-wing government led by Corbyn may see 30-year and longer tenor gilts reflecting higher credit risk, steepening the 10-year/30-year curve, as seen during the fourth quarter amid heightened no-deal Brexit fears.
• Increased expectations of an expansionary fiscal policy will see the market unwilling to keep sizeable risk further out on the curve. That could see weak take-up of any long-dated syndications.
• The gilt market is heavily reliant on foreign demand and may suffer if Corbyn is perceived as fiscally irresponsible.
• Although many permutations exist and the path to an election is far from certain, it will only take a growing expectation of one to realize profit on a 10s30s gilts curve steepener.
• The markets remain skeptical following May’s move, with an outright short gilts view requiring confidence that a compromise will emerge.
• A long extension could increase the chance of a general election. The likelihood of a delay to Brexit is being reflected in sterling swaption volatility, with 2m2y implieds not particularly showing any aggressive near-term jump risk (implying terminal breakeven on a straddle of around 14 basis points).
• NOTE: Tanvir Sandhu is a global interest-rate and derivatives strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice

To contact the reporter on this story: Tanvir Sandhu in London at tsandhu17@bloomberg.net

To contact the editors responsible for this story: Ven Ram at vram1@bloomberg.net, Scott Hamilton, Neil Chatterjee

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