Everyday, Everyday I Have the Blues
By John Stoltzfus,
Chief Investment Strategist
The Gunboat of Populism
The Brexit vote may signal that the keel is deeper than anyone expected
If there was a lesson that stood out to us as a result of the referendum on Brexit last week it was that the gunboat of populism has a much deeper keel than anybody expected.
For all the warnings that British voters heard from political leaders, corporate spokespeople, policy experts as well as denizens of the markets around the world about the risks of a pro-Brexit vote, it was the frustration of a large enough segment of the population that felt disenfranchised from the status quo of crossborder economic realities that defeated the “Bremain” camp and pushed the fifth largest economy in the world into a process of unwinding the intricate and highly complex crossborder agreements that have joined a region of the world for over 40 years.
For the immediate future not knowing how the outcome of Brexit will unfold increases the levels of uncertainty that markets will have to contend with on a day-to-day basis for the foreseeable future.
The good as well as the bad news surrounding the process of the UK’s exiting the EU is that it will likely take place over a two-year period and perhaps longer due to the complexities of the agreements that will have to be unwound or altered to reflect a new order.
The length of the process would seem to reduce the chance of rash decisions making the situation worse, while the longer the process takes, the more complex, unwieldy and challenging it may become.
Beyond the singular unwinding that has only just started for the UK and its trading partners on the Continent, the precedent being set is likely to increase the likelihood of other member countries to make a break for the door and away from the union.
Among the countries considered to be prospective candidates to consider an exit in the future are the Netherlands, Spain and Italy.
From our perspective on the radar screen we feel it is important to recognize that last week’s vote was a political event with likely economic repercussions for the UK and the European Community. It wasn’t the other way around (i.e., not an economic event).
Ironically though, it may well have been the uneven economic outcome of politically driven economic agreements that tied highly disparate political, social and business cultures together that led to the current disillusionment with the EU.
In the days that have followed since the vote it has remained clear that a “let them eat cake” response to the situation is not an option.
Genuine fundamental uncertainty is the order of the day and for the visible future while policy makers on the Continent and in the UK work the process.
Jarring as the outcome of the Brexit vote was to the market’s last Friday it was less about panic and more about a knee-jerk reaction.
The weekend has provided some calm after the storm to assess the damage, but so far there’s no rainbow apparent.
What we expect near term:
Stateside today markets will likely reflect on what markets did in Asia overnight and where the European markets are at mid-day.
Follow-on selling to Friday’s action may occur into today’s stateside opening and wouldn’t be surprising. That said, we see opportunity for US markets to turn up by the middle of or later in the week.
It appears to us that the stateside economy, with 70% of its growth anchored by the consumer, won’t be severely impacted by what is happening across the pond.
However, the dollar’s resurgent strength as a haven currency evidenced last week could have a negative impact on revenues and earnings of US multinationals if the dollar continues to move much higher. As of the end of last week, the dollar as tracked by the DXY index was off 3.23% year-to date inclusive of Friday’s rally of just over 2% (see figures on page 4 for Friday’s currency market action, was well as currency movements in the year to date).
Abroad we expect concerted action by central banks will help to quell roiled markets sooner than later.
In the UK the BOE is talking about perhaps another rate cut. In our view, Brexit could reduce UK 2017 GDP to 0.2%. The BOE may introduce a 50 bps rate cut in July and perhaps add as much as £50B GBP in quantitative easing purchases (QE) to offset the possible damage done to the UK economy by Brexit.
Low interest rates for longer will extend the process of normalization stateside. Concerted efforts by 3 central banks in Asia and across the pond should
help to offset challenges to the economic recovery’s progress in Europe.
The outcome of the Brexit referendum and its effects on the markets worldwide last week remind us of the words attributed to the late Yogi Berra, “It ain’t over ‘till it’s over”
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