Markets would price in some of that break-up risk straight away. Along with falling equity markets, a sliding pound and emergency rate cuts by the Bank of England, European bond markets would suffer a swift and savage correction. The speed with which money would flow out of southern Europe would only be matched by the speed with which the share prices of UK banks could collapse.
Ten year Bund yields could go deeply negative, perhaps as far as minus 0.5%, while peripheral countries’ yields would gap out by up to 50%. For Italy, that would mean shooting up from 150bp to 225bp. Periphery FIG debt would also be hit hard, especially down the capital structure. Corporate spreads in Spain, Portugal, Italy, Ireland and of course Greece would rocket as investors are left wondering just what they have purchased over the last six months on the back of the European Central Bank QE trade.
The one way corporate QE bet that has tightened credit spreads to levels no longer reflecting the fundamentals will not be looking such a dead cert come next Friday.
Primary dealflow will of course be hit as issuers and investors search to find the new yield levels. Issuance will eventually resume, of course. But the disruption comes at a terrible time for the European capital markets. FICC revenues across the Street were down between 30% and 65% in the first quarter and some banks’ DCM revenues were down 25%. These are catastrophic numbers that have left capital markets and the people who work in them vulnerable like never before. For some, Brexit could be the final straw.