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Tags: brexit | economy | investors | dollar

Don't Be Fooled: Worst Brexit Fallout Is Still to Come

Don't Be Fooled: Worst Brexit Fallout Is Still to Come
(Stock Photo Secrets)

By    |   Wednesday, 29 June 2016 09:41 AM EDT

So far, the most important global markets are all in positive territory. The British pound wasn't falling further.  Gold remains comfortably above $1300 per ounce. The  10-year U.S. Treasury note yield remains little changed and WTI crude oil is up thanks in part on a strike threat in Norway.

Does this tell us, the worst impact of the Brexit vote is over, or is there a possibility that Brexit could be avoided?

In my opinion, the worst is still to come.

While on the first day of the EU leaders’ crisis summit (June 28-29) in Brussels there wasn’t any sign of clarity on the way forward for UK exit negotiations. Interestingly, UK Prime Minister Cameron said he lost the EU referendum because the EU leaders failed to address public concerns over immigration.

As things stand today, Brexit will not go away under “normal circumstances.” Therefore investors could do well paying attention to the coming policy responses to that challenge.
This is complicated because the economics of a UK exit is potentially more serious in the median term around trend growth, than it is in the short-term cyclical sense.

Nonetheless, in the short term there are also several global transmission mechanisms.

First, we should not forget the United Kingdom is the fifth largest economy in the world and the second largest economy in the EU, which means that a UK economic sharp cyclical slowdown, which is now widely forecast will transmit through weaker global demand, which is already mediocre, at best.

Second, there is a wealth effect from the reaction of assets markets. That however is not too significant as wealth effects are generally not as important as people think.

Third, there is the uncertainty, which is more than uncertainty about the UK alone, though it will be the most intense in the UK, but it extends also to the future policy direction in the EU and the Euro area.

So, what stimulus will work in this environment for countries other than the UK?

Currency moves by other countries are likely to be largely ineffectual.

The UK is unlikely to see a surge in domestic demand because, for example, the Brazilian real weakens against sterling. Tackling the problem with what amounts to an external demand shock with currency weakness risks becoming a race to the bottom and it never works.

Central bank policy stimulus may be more effective assuming there is not a domestic credit bubble already. It also assumes that domestic credit can substitute for international demand, which is of course another question.

This leaves fiscal policy, which when properly applied, is likely to be the most effective international remedy to the shock of lost demand from the UK.

Markets are now inevitably turning from the negative shock to the possible positive stimulus remedies, which is a “Pavlovian” reaction as there is now a generation of traders who have really only ever known the post 2007 policy environment and do think that every crisis means stimulus and stimulus means crisis.

The focus initially will be on Central bank policy because that can react more quickly and because traders are used to thinking purely in terms of what Central banks can do.

However, this may be inappropriate as a response to the current situation.

In the meantime, we have learned Mr. Cameron’s successor should be known by September 9, and it is him/she that will have to negotiate the exit conditions.

Investors should better remain calm, which doesn’t mean they should become complacent.

Today’s situation does not allow uncertainty to be cleared up for a long time to come, which will cause permanent risks of spikes in volatility, again, for a long time to come.

Long-term investors should also better keep in mind the Netherlands, Austria, Italy and France are all Euro area countries where the risk for a referendum exists and of which Italy has the potential to pose a greater medium-term challenge to the euro area's stability because of increasing Euroskepticism and growing support for the anti-establishment 5 Star Movement is likely to raise the probability of a referendum on the euro in Italy.

Finally, Fed Governor Jerome Powell said in prepared remarks: “For some time, the principal risks to outlook have been from abroad. The Brexit vote has the potential to create new headwinds for economies around the world, including our own. As the global outlook evolves, it will be important to assess the implications for the U.S. economy, and for the stance of policy.”

Etienne "Hans" Parisis is a bank economist who has advised global billionaires and governments on the financial markets and international investments. To read more of his articles, GO HERE NOW.

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Long-term investors should also better keep in mind the Netherlands, Austria, Italy and France are all Euro area countries where the risk for a referendum exists.
brexit, economy, investors, dollar
Wednesday, 29 June 2016 09:41 AM
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