EURO 2016 Research View on Brexit

Redacción - Sabado, 25 de Junio

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Mayhem after the UK leaps into the unknown  

The outcome of the UK referendum took investors by surprise. Today will feel ‘crashy’ as insurance contracts are triggered. The next steps are contagion risks and policy reaction.

​A historical day lies ahead of us – UK voters decided to leave the European Union. Despite close polls this is a major surprise to investors given the odds earlier on. The reaction will go in waves. The first wave is rolling and refers to the unwinding of insurance contracts, in particular on the currency side. This will take place mostly today and maybe also some trading days next week. The second wave will be about contagion. Is this the end of the European Union, and other similar questions. The only way of reading this is to monitor bond spreads of peripheral European sovereigns in the coming days. Should they rise, the market is preparing for break-up. The third wave will be about policy reaction beyond the initial comments of European politicians and mitigating central bank interventions. This will take weeks if not months. The outcome of the UK referendum took investors by surprise. How to cope with this? 1) Stay calm, this is not the day to act in a major way, 2) stick to quality and 3) look out for bargains in assets you always wanted to own but that always looked pricey.

 

Forex markets are showing typical shock reactions today, all the more since in the past days they probably had become too comfortable with the idea that the Brexit would be rejected. The Sunday press will surely offer a detailed analysis of the surprising outcome of the vote. It is still too early at this stage to discuss about what the events mean for the UK political landscape and stability, how or when Article 50 of the Lisbon Treaty will be triggered, or what it means for the European Union as a whole. On the currency markets, the pound sterling is suffering the most, as expected, while safe havens such as the JPY, the USD and the CHF are facing upward pressure. While for most currencies the shock could abate in the next few days, we expect the pound’s weakness to continue, as fundamental factors will kick in, such as the expected meltdown of foreign direct investments.

 

As already indicated by the futures market the UK equity market could see a substantial setback today. Setbacks in the UK will likely affect other equity markets in Europe as the relationship between UK and European equities must not be underestimated and Eurozone markets are the most interlinked in terms of economics and politics. Also, discussions about a breakup in the eurozone, which are flaring up on a more or less regular basis, could be fuelled again.

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