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Brexit: first day of the rest of your life

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27 th June 2016
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By the time you read this it will be close to 84 hours since the result of the EU referendum was announced. The major impression appears to be that having lived through a period of great uncertainty in the lead up to the referendum, it is unlikely that this mood is likely to lift any time soon. Indeed, given that the Leave camp does not seem to have any policy in regard to even beginning the process by invoking Article 50, any hopes of a revival in business activity are likely to be very muted.

Most of the fallout from the referendum result so far has been limited to the political classes. At the time of writing, 17 members of the Labour party’s Shadow Cabinet have resigned, calling for the head of their leader following his miserable efforts to persuade Labour voters to support the Remain cause. At this stage it appears that Jeremy Corbyn is trying to ride out the storm. Not so with David Cameron, who clearly perceived his time was up, though he has decided to hang around until a successor is found. His timescale for this interregnum is to the beginning of October, so one assumes that the two year exit under Article 50 will not start until then at the earliest. One can only assume that George Osborne will be joining him on the back benches in fairly short order. Perhaps a just result, given his miscalculation of the response to his warnings of doom and destruction.

There was a lot of talk and verbiage in the media over the weekend about the response to the referendum in the financial markets. It is very unwise to try and make any longer-term predictions based on one day’s trading after such a cataclysmic event. In summary the FTSE fell by over 500 pts before recovering to being just 2.7% down on the day (most European markets finished lower than this), the big mover being GBP/USD which fell from a high of just over 1.5000 to close just under 1.3700 (having been down to almost 1.3200 en route). These are big falls granted, but it has to be remembered that both GBP and the FTSE had been trading strongly prior to last Thursday. Just one week before the vote GBP/USD sat at 1.4100. Markets then proceeded to price in a Remain result for the following 7 days, before the crushing realisation on Friday morning that they had judged the public mood very wrongly. How the markets managed to persuade themselves into almost certainty that Remain would win will be debated endlessly. Although sterling has weakened significantly and will surely remain offered until the dust settles, given last week’s pre-vote rally, the scale is not quite as dramatic as it seems on the face of it.

Rates also took a huge fall both on Friday and again this morning. There is absolutely zero chance of the Bank of England raising rates anytime soon, save for a currency crisis, and the market is now pricing in a cut before any return to a move towards normalisation. However, Mark Carney has called for stability and we do not think that he will be in any haste to change monetary policy until there is a clear requirement to do so.

The GBP 5 year rate fell from 1.10% on Thursday evening to just 0.62% by lunchtime today! This is incredibly low and is driven solely by uncertainty rather than fundamentals (unless you think Brexit spells doom for the economy over an extended period), but it seems likely that rates will continue to stay in this range until a clearer picture emerges, particularly in the 3-5 year period. Futures markets are currently pricing in no rate rises until 2020, which seems entirely unrealistic, but having been burned so many times over the last few years over expectations of rising rates, the market is in no mood to contemplate an increase in rates on any rational timescale.

Mark Carney, while calling for stability, has made it clear not only that the banking system is in a much stronger position than before the 2008 financial crisis, but also that the Bank of England stands ready to support the UK banks with substantial financial resource if required. We very much doubt that it will be needed despite the cost of CDS (credit default swaps) having risen by about 40% since the election result. We have also spoken to several lending banks to gauge their response in terms of making new funding available. Most are, understandably, somewhat coy over their likely response to requests for new finance and are busy reviewing loans that were due to close over the next few weeks to ensure that the credit assumptions underlying those loans have not been adversely affected by last week’s events. We suspect that as long as the mood of relative calm survives over the next few weeks, banks will return to the lending market with a similar enthusiasm to before the referendum.

There is one big question hanging over this relatively relaxed short(ish)-term view. The UK still has a large budget deficit and, rather more worryingly, a rapidly increasing current account deficit. It seems inevitable that the UK will suffer a downgrade in its credit rating, and if this results in foreign investors turning off the taps, all bets are off.

That said, we are now living in strange times and it is not outside the realms of possibility that before the end of the negotiations with the EU, the EU itself might disintegrate. The Dutch and Danes are pressing for their own referendums and would appear to have a greater proportion of eurosceptics than the UK. So does France, where Marine le Pen has taken to being photographed in front of a Union Flag.

Most domestic economic releases will be ignored this week as traders concentrate on events political. The one exception is likely to be the latest update on the current account (as noted above). Currently standing at a record deficit of £32.7 bill, the markets are expecting a slight, and very overdue, contraction. Also out are the latest money supply and mortgage application data (on Wednesday) as is the PMI survey of manufacturing industry (on Friday).

We understand many readers will have concerns about how markets are trading. Please do not hesitate to contact us to discuss any of these concerns, particularly with regard to any FX exposures you may be facing.

All views expressed here are the author’s own and are based on information and data available at the time of writing.

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