Tales of a Brexit

Investors this morning are still wrapping their heads around the ramifications of the Brexit vote. Many people are still in denial about it all, with conspiracy theories about ignoring the vote, the Scottish parliament blocking the exit from the union, and rival political parties already claiming that a vote for them in the next general election would be a vote for re-joining the union. What a mess!

Despite all this confusion, although markets have experienced a significant knee-jerk reaction, it hasn’t turned out to be the financial meltdown people expected on that fateful Friday morning, or at least not yet.

Inevitably there have been comparisons to the most recent financial crisis in 2008-2009; however this is clearly different. During the financial crisis, world economies were faced with instant instability and risk of financial Armageddon as the financial institutions were at breaking point. With Brexit, the effects on the British, European and world economies is expected to be more long term in nature, and quite frankly quantifying the repercussions is very difficult at this point as much will depend on the future relationship that the UK will have with its European counterparts.

The situation we find ourselves in is one of uncharted territory, and markets are reflecting this. This morning we find ourselves in a highly volatile, illiquid market where most asset classes are trading sideways or marginally weaker. The flight to safety has had some follow through, with the German bund (10 year) trading tighter by 8bps to reach -0.08%. Unlike the reaction witnessed last Friday, peripheries are also trading higher, buoyed by the positive results of the Spanish elections over the weekend. The Spanish 10 year in fact is trading 9.2 bps tighter at 1.528% with all its European counterparts except Portugal and Greece trading in the green.

Gold remains being a safe haven asset in demand, consolidating its position as one of the best performing asset classes this year, up around 25% since the beginning of the year. Given the uncertainty imposed by Brexit, I would expect this asset class to remain supported in the near term.

The equity markets have been naturally impacted, as investors weigh the costs of Brexit in relation to future earnings potential. An interesting statistic is that despite the selloff, the FTSE closed down “only” 3% on the day. Other bourses were more greatly impacted, notably the German DAX, down 6.72% possibly on the fear of the future of the union. This morning we are seeing mixed trading as result of negative Brexit sentiment and positive Spanish election news. After an initial upswing, most bourses are currently trading around 0.5% to the negative.

The most talked about asset class over the weekend must certainly have been the sterling, with European investors already calculating their cost savings for their British holidays as the pound plummeted against the euro to levels not seen since the height of the financial crisis in 2009. This morning the pound fell a further 1.4% as of this writing, currently at GBP 0.824 / euro.

This week we expect further signs of support from the European institutions with Central Bank Governor Mario Draghi expected to release a statement while hosting a three-day meeting in Sintra, Portugal that will include speeches from Federal Reserve Chair Janet Yellen. German Chancellor Angela Merkel will host EU President Donald Tusk in Berlin today to talk about the U.K.’s plan to exit the bloc. Cameron is due to address British lawmakers this morning also.