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Brexit – It Is Not The End, It Is Just The Beginning


GBPUSD – The Great Collapse

Source: Thomson Reuters To the average man, Brexit remains a remote event, limited to an opportunity to buy Sterling (GBP) at a 6% discount or re-entering the local markets at the cheap. In fact, several commentators in today’s edition of local newspaper (The Sunday Times) has remarked that last Friday’s sharp sell-off as a good buying opportunity. But is it really just a British-EU problem?

The current optimism is a dangerous one. Apart from the short-term volatility in financial markets, the full extent of implications from Brexit has yet to be felt on the political and economic front. It is this political uncertainty, stemming from lack of leadership and vague course of action, may have far-reaching consequences down the road. Racism and xenophobia has already found its way to mainstream social media while political brinkmanship has reached new highs. Stable politics is fundamental to economic prosperity.

Brexit Vote and Politics The EU referendum was not only important for the British, but other euroskeptics of the EU member states as well. An exit plays into the hands of the nationalistic camp which before recent migrant crisis had less voice. Several member states have seen increasing calls in factions of the country for referendum on EU membership. Fortunately, there aren’t any similar to UK’s scheduled yet. But German and French elections due next year will be closely watched, as a proxy for EU unity. For the UK, the situation remains sketchy apart from the 3-month timeline and resignation of UK Prime Minister David Cameron. The loss of political leadership within UK and quick rebuff by certain EU members stating that “UK must not delay leaving” further add to the uncertainty. It will be important to watch the political developments in the coming weeks to better guesstimate the true implications and impact of UK’s exit.

Economics – A Temporary Shock or Permanent Damage?

Beyond the sell-off in GBP and equities, a British economic downturn is almost inevitable and is likely to spill-over into the regional and global economy, especially against an already deflationary global economic backdrop. Overnight, household wealth decreased by 7-9% as a result of a weaker British pound, and weaker external balances will further hurt the economy. Consumer purchasing power will be curtailed and domestic investments cutback. UK is likely to see continued capital outflows stemming from foreign investors cutting losses on their GBP-denominated assets and rebalancing portfolio away due to a poorer UK economic outlook. Not to add the potential trade-related costs of exit - migration of jobs (most notably in the financial sector), increased trade barriers – are likely to magnify those flows. Market Implications The GBP (-7.3%) will continue to weaken as long as outflows and economic weakening persist. Given the longer-term political implications for the EU, it is surprising that the Euro (-2.2%) had been relatively ‘resilient’ although I expect it to change as the situation unfolds. Yields are likely to come off (German bunds 10y yield remained below 0% on Friday while US 10y flirt with historic lows) and likely to go lower as central banks continue their plot of “extend and pretend” (extension of easy monetary conditions and pretend that all’s ok).

S&P 500 Struggling To Break Higher Since July 2015

Source: Yahoo Finance

Likewise, it doesn’t bode well for risk assets (equities, high-yield bonds, emerging market currencies etc). Judging by how global equities have been struggling to break new high for a few months now, and an immediate 4-7% sell-off in developed markets last friday, the risk is to the downside. Equities are likely to face de-rating risk while risk appetite remains poor. Government bonds, together with CHF and JPY assets have outperformed in the past week. That said, given the limited access to some of these instruments to the average investor, cash (and perhaps gold) may be the next best safe haven asset to own. After all, sometimes the best thing to do may be to sit around and do nothing at all.


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