Brexit Outcome Still Too Close To Call: Deutsche Bank

Though the Brexit risk premium was partly reversed with the recent swing back in favor of Remain, the outcome of the referendum remains too close to call, note Deutsche Bank analysts. A material shock from the U.K. referendum would trigger a forceful central bank response, while absent a shock, attention should shift back to fundamentals, wrote Marcus Arana and colleagues in their June 21 research piece titled “Brexit: Decision time.”

Brexit risk pricing partly reversed

Noting that the June 23 U.K. referendum has been the dominant theme for the markets for quite some time, the DB analysts point out that the markets went from pricing in very little odds to pricing about 50-50 odds as the Leave side gained momentum. However, they argue that the subsequent partial reversal in polls has led to some unwind of this risk premium.

Arana and team note that the referendum has become the key driver of markets with sentiment swinging with opinion polls and betting odds. They point out that there has been a sharp drop in core rates to multi-year lows with German 10-year yields dropping below zero for the first time ever:

As Brexit risk pricing was partly reversed with the recent swing back in favor of Remain, the DB analysts expect the market response to be stronger if the Leave side wins in the upcoming Brexit referendum. The following table captures the likely market reactions as anticipated by the DB analysts, following the outcome across various asset classes:

A Leave result could trigger new U.K./ EU terms

Arana and colleagues believe a Leave result in the upcoming Brexit referendum will trigger a priority of negotiating new U.K./EU relationship terms, though the process could take longer than two years. They believe that until new terms are agreed upon, the U.K. would continue to be a full-fledged member of the EU, though in practice, the U.K.’s influence would likely wane. Though there are several templates of what post-exit terms could look like, it’s reasonable to anticipate that the U.K. will strike a unique deal, wrote the DB analysts:

The DB analysts believe a U.K. exit from the EU could have material repercussions for the future of the EU. They expect in the immediate aftermath of a Leave result, the EU is likely to respond with increased “pro-Europe rhetoric.” The analysts underscore that, irrespective of the results of the vote, the referendum will likely have profound repercussions on U.K. politics. The following chart captures three possible end-game scenarios for the EU:

Arana and team prefer the U.K. over Germany in European equities, irrespective of the Brexit referendum outcome, as the FTSE should benefit from a weak GBP: