Sovereign bonds may very well end 2016 as one of the most volatile securities. Given the Brexit fears in the UK and the outcome uncertainty of an upcoming general election in the US, investors may very well cling on to safe haven assets despite any possible turn in commodity prices.

The sterling took a dive on Monday against a number of peers as Brexit fears mounted following London mayor Boris Johnson’s campaign announcement to support the UK leaving the Eurozone. At pixel time, UK Gilts have widened by approximately 120 basis points since the announcement and the Sterling has recovered losses of 32.6 basis points against the Euro, strengthening back to near pre-announcement levels following the GBP sell-off. The presentiment is a jittery one for investors on the economic outlook and implications of a Brexit on the United Kingdom (UK).

The long term benefits may very well outweigh the short term drawbacks for the UK, notably in terms of trade flows. Currently the UK conducts close to half of its trades with the EU, bypassing potential ameliorations of trade flows with Non-EU members such as the US, China and India amongst others. Conversely, a Yes vote to a Brexit would trigger a relocation of some UK firm headquarters such as HSBC to within a Eurozone country. Such moves combined with nervous investor sentiment would undoubtedly result over the short to medium term in a depreciated sterling value and large capital outflows, bringing possibly the FTSE and UK gilts to potential 5 year lows.

What alternative do investors face?

Eurozone data has been far from stellar. Inflation data in France has in fact been revised downwards this week, as February PMI came in below expectations. The French 10 year bond has widened by 40bps since Monday’s close. German manufacturing PMI also came in below expectations yesterday, strengthening the possibility of Investors seeing a Quantitative easing (QE) extension package by the ECB in March. European equities and high yielding debt securities would be the main asset classes to benefit from further QE. However, risk-averse investors would find little comfort in investing in such asset classes given the weak global confidence, volatility and political risks currently being seen in financial markets.

This limits the possibilities in times of turmoil down to safe haven assets such as sovereign bonds and possibly Gold. Gold’s value is historically proven to remain fairly constant over time and act inversely to the USD. Investor exposures to a depreciating USD may very well opt for the commodity.

Granted, the situation is not one of a depreciating USD, so Gold may not be the option. Although investor concerns have pushed back expectations of further rate hikes by the US Federal Reserve (the market is pricing in a 10% probability of a rate hike for March), hedge fund managers remain fairly optimistic that the slowdown in the US in not leading into a recession, by remaining allocated to cyclical discretionary stocks, which theoretically generate most gains in a strong economy.

Having said that, US equities have rebounded this week on optimism of a resolution to the oil crisis currently dragging world equities from contributing to economic growth. Should oil prices stabilize, the US economy and notably equities may still find themselves under pressure from the uncertainty of president elections due in November of this year in addition to soft economic data.

So the most cautious option for the risk-averse investor in today’s economic environment may very well be to remain allocated to sovereign bonds, notably European, as the strong possibility of a QE extension would benefit the asset class in hand with most European asset classes. US sovereign bonds could also be an option, but the direction an appreciating USD vs the EUR, as a result of equity sell-offs, would have on capital outflows remains uncertain.

This article was issued by Mathieu Ganado, Junior Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt .The information, views and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.