Brexit impact – What happens now?
The shock Brexit decision has caused markets to re-evaluate expectations for economic growth especially for the directly impacted regions of the UK and Continental Europe. While the process for the UK to extricate itself from the EU will be a long and tortuous one, the uncertainty resulting from this will no doubt impact on growth, as businesses in particular will be deterred by the lack of certainty concerning the likely future operating environment. Banks in the UK and Europe will come under particular scrutiny and regulators will be keen to ensure they are sufficiently capitalised to withstand the impact of a downturn in activity. In the first instance, the ruling Conservative Party needs to elect a new leader to become Prime Minister as a precursor to beginning the process of leaving the EU. There has been recent speculation that this would require a Parliamentary vote, as the referendum was non-binding. This raises the question of what would happen should this not pass, effectively repudiating the result of the referendum. One possibility is that the new PM could call a General Election, which would in effect become a second vote on the Brexit issue. While all sorts of permutations are possible, the most likely scenario is that the UK will ultimately leave the EU, as it would be hard to imagine that any government would defy the will of the people after such a long and bitter campaign that tragically claimed the life of an MP. It should also be noted that although the vote was close, the margin of victory of 1.3 million votes was a clear mandate for change.
Global Monetary Policy – Lower for longer…. and longer still
In addition to a more accommodative stance on the part of the Bank of England and the ECB, the US Federal Reserve is now also likely to delay its next rate hike as part of its interest rate normalization program, possibly into next year. The Reserve Bank of Australia is likely to cut cash rates a further 0.25% in August both as a consequence of Brexit but also the uncertainty concerning the Federal Election outcome in early July which remains unresolved at the time of writing. This once again reinforces the “lower for longer” theme that has been prominent now for some time which will see central bank policy continue as the primary force driving financial markets. Heightened risk aversion has been most evident in global bond markets. The flight to safety has pushed sovereign bond yields to historic lows. While US 10 year treasuries have been the main beneficiary of this trend, global bonds in aggregate returned a healthy 2% for the month of June alone with markets like Germany, Japan and Switzerland actually trading on negative yields
Investment Outlook
There is no doubt that the financial market ramifications of the Brexit vote will be felt for some time as this was a typical “Black Swan” event that took markets completely by surprise. As a result, investors are in the process of readjusting expectations concerning growth prospects, profits, currencies and interest rates. Volatility in markets has risen sharply as indicated by the white line in the chart below showing the Chicago Options
Exchange Volatility Index. Given the turmoil in the UK and Europe and on-going uncertainty in other major countries such as Japan and China, all eyes once again turn to the US as the primary engine for the global economy. While Brexit will have some impact on the US, the health of its domestic economy will be closely monitored by the Fed with a particular focus on employment and wages growth. An added issue for them to consider is the looming Presidential Election to be held on November 8th, with both major parties selecting particularly combative and polarising nominees in Hillary Clinton and Donald Trump. The UK is not a major trade destination for Australia with only 2.4% of our exports going to that country as many of our agricultural products were shut out of the
