European credit investors identified geopolitical risk as the biggest threat to their market before the UK’s referendum on EU membership, according to Fitch Ratings’ latest senior investor survey.
Three-quarters of respondents to our 2Q16 survey said that geopolitical risk posed a high risk to European credit markets over the next 12 months. The next most common concern was prolonged economic weakness (67%). No other factor was identified as a high risk by more than half of respondents. The survey closed on 23 June, the day the referendum was held but before the outcome was known.
Geopolitical risk has been among European credit investors’ top worries since the Ukraine crisis erupted in early 2014. But the level of concern fell last year. In our 4Q15 survey, just 55% of respondents identified it as a high risk.
By the time of our 1Q16 survey which closed mid-February, as investors became more bearish on a range of risks, the proportion had risen to 77%. Various factors may lie behind the return of geopolitical concerns. Turmoil in the Middle East has affected Europe via ancillary issues such as terrorist attacks and migration. Political fragmentation and polarisation have been evident in the aftermath of the eurozone crisis, leading to inconclusive elections in various countries, including Spain.
Fitch believes that the UK referendum will add to political uncertainty in Europe. Formal exit negotiations with the UK have yet to start and could open up more disagreements. We expect the referendum outcome to boost support for more radical, populist parties. This will reduce governments’ willingness to implement unpopular economic reforms, while we are sceptical that there is political willingness to deepen EU or eurozone integration in response to Brexit. Combined with the potential economic impact of Brexit, these factors are credit negative for EU sovereigns.
Brexit’s impact will also be a factor of the response by policy makers. This could take the form of further monetary easing, through interest rate cuts or expanding asset purchase programmes (QE).
However, investors have expressed doubts over the economic impact of such measures. Only 22% of the respondents to our survey said that negative policy rates add stimulus to the economy. 41% said that the costs to the financial sector made them a bad idea and 37% said that they will not work, as savings need to increase to generate the same investment income.
In the same vein, just 15% of respondents thought ECB corporate bond purchases would benefit issuers across the credit spectrum and fuel investment and economic activity. Far more (59%) thought ECB buying would only achieve a temporary repricing and boost to issuance. 26% thought it would support investment-grade issuers, but because these are already cash rich, ECB purchases will not generate additional investment.