If there was any doubt 2016 was proving to be a boring year or rather a foregone conclusion, June 24th changed everything! What is even more astonishing is that the referendum was meant to be a mistake, a political ploy. This miscalculated game is going to change the shape and structure of the European continent as we speak. No one can really predict how this will turn out as there are so many moving variables. But when the Brexit campaign leaders themselves look clueless caught with their hands in a cookie jar, it is undeniable that the uncertainty is here to stay.
From a trader’s point of view, coming into Friday morning to see Sterling down ~ 10% in one day, and broader developed market currencies down between 300 and 700 bps, in some sadistic way we couldn’t help but appreciate the enormity of the moves on the open as we were making history! The moves witnessed have never been seen even during 1997 Asian Financial Crisis, LTCM blow up in 1998, 2001 Tech bubble, or 2008 Lehman collapse. There was no precedence or historical charts to follow. We were in unchartered territory, and will continue to be so until the UK government gets it act together and some semblance of policy rules the country.
The regions who voted “leave” had no clue that leaving would hurt their own revenues as most exposed to the EU. The pensioners who were so keen to protect their retirement, their pensions just went further into negative territory with no signs of returning. Reality check! Slogans of independence were sang across the “leave” regions, but “independence from what and whom” I am forced to ask? It is ironical to see The Great British Empire, the largest Empire in the world at its height, now diminished to one tiny island.
Emotions and philosophy aside, it is always important to take a step back after the initial knee jerk reaction and think about the real impact vs. the expected impact of any exogenous event. The fall in the Sterling will have a knock on effect on local banks, risk assets and companies exposed to revenues from the EU. The impact from leverage and correlation that exists amongst all asset classes will be much bigger. When one sees moves of this extreme in one area of the market, FX, there is usually a domino effect felt in other asset classes as well. Funds and institutions that take on leverage on their portfolios to maximize returns, when volatility rises this fast, they are forced to cut risk even faster as they face margin calls and have to manage their pnl. Everything gets sold down in tandem outside of fundamentals.
It goes without saying that UK GDP growth forecasts will be lowered on back of the potential loss of trade, which will effect US and Europe GDP as well. All in all, this is a deflationary shock and every central bank will come charging in with their cavalry to save the day to offset any growth shocks in the European continent. More than 30% of the global bond market is already in negative yield territory with the German 10yr bund trading at -0.1% and Japanese 40yr bonds at close to 0 now. How much more can the Bank of Japan and ECB do? The market had as it is given up on their accommodative policies since start of the year as the Euro and Yen defied their obvious path and outperformed the USD for most of 2016. Rather than point fingers, perhaps they should start singing to Flo Rida’s tunes by adding another “low” to the chorus.