What now for Brexit punished markets?

See the latest Australian dollar analysis here:

Macro Afternoon

 From Morgan Stanley:

We see GBP moving to 1.25-1.30 and 15-20% downside to European equities relative to Thursday’s levels. Corporate and sovereign credit present the best opportunities to buy on weakness

  • Economic implications: The UK faces a prolonged period of uncertainty which should lead both investment and consumption to wane. Longer term, a less open economy could lower the UK’s rate of potential growth. Risks to the economy will likely lead the Bank of England to keep an easing bias – staying on hold through 2017-18, or a rate cut to 10bp with further QE depending on exit negotiations.
  • What has furthest to fall: Negative implications extend beyond the UK. We see the most downside in GBP and EU equities, and would also be sellers of AUDJPY (target 70), USDJPY (90) and EURCHF (1.02) on a flight to safety. Gilt yields could rally 30-35bp to all-time lows, but breakeven inflation could ultimately rise, given weaker GBP. In EM FX and local rates, sell Poland and South Africa.
  • Where to be brave: ECB support, both potential and existing, argues for buying corporate and sovereign credit into weakness. We discuss levels and our expected central bank response.
  • FX: Poor fundamentals could support 10%+ downside in GBP. Higher global volatility favours JPY and CHF. Increased concerns over eurozone vulnerabilities make PLN the best short in EM.
  • European equities: We expect significant downside for European stocks – SX5E at 2400-2550 and FTSE 100 at 5000-5300. Financials and Consumer Discretionary will likely lead the market lower, while Staples and Healthcare should outperform.
  • Credit: We expect a strong response from the ECB – we’d add risk in CSPPeligible assets and ‘A’-rated ineligible non-fins on initial weakness. We’d also add bank credit selectively on what we expect will be materially lower prices today – UK banks’ LT2 and AT1s have best asymmetric returns.
  • European rates: We reiterate our long duration recommendations and believe UK yields could rally 30-35bp. GBP depreciation should be a dominant force on inflationary pressures over the next two years – long Nov-18 UKTi breakevens. The decline in global yields could see 30y UK real yields return to all-time lows; we reiterate long Mar-46 UKTi real yield. BTP spreads moving more than 25bp would represent value to ‘buy on weakness’, in our view.
  • EM fixed income: We expect risk-aversion to widen the impact beyond countries with direct UK links. We see Poland and South Africa most exposed in rates and FX, and South Africa and Turkey most exposed within EM credit.

Cross-asset implications: Bracing for volatility

It looks likely that the UK has voted to leave the EU. This result will come as a surprise to markets, based on Thursday’s pricing, and creates material political and economic uncertainty in Europe. Both are negative for risk premiums, and the question over the next several days is not whether prices fall, but by how much, and whether central banks respond.

What level of sell-off is warranted? A great deal of uncertainty hovers around all of our estimates in this scenario. Generally speaking, we see the most downside in European FX and equities. We think both European corporate and sovereign credit will be better insulated, given central bank support.

Specifically, we think GBPUSD could trade down to 1.25-1.30, as valuations need to adjust sharply before the currency is ‘cheap’, in our view. EURUSD could fall to 1.05 over the next six months as its correlation with risk flips, reverting back to the pattern seen in 2011-12, when EUR served as a proxy for European cohesion. JPY and CHF, in contrast, should be well-supported. We think European equities could sell off by 15-20%, on a ~5% hit to earnings and de-rating the P/E back to near historical averages. Within equities, we prefer to be defensive,  favouring Staples and Healthcare, and our ‘Weaker EUR beneficiaries’ basket (MSSTWKEU).

While spreads should also widen, we think corporate and sovereign credit stand to outperform FX and equities significantly, given the ECB’s outstanding purchase programmes for both. We expect CDS to materially underperform cash, with XOver moving out towards 450bp.

What to watch for? All eyes are now on the ECB, and how aggressively it decides to intervene in order to protect its member states and deflect downside risks to inflation that could result from increased economic uncertainty. In the very short term, we think the ECB could reassure markets about liquidity provision (including via FX swap lines and emergency liquidity assistance) today. We would also watch MS GRDI* (STGRDI <Index>), our preferred sentiment measure, dropping below -3, for assessing if the sell-off has run its course. We see US assets across the spectrum – stocks, FX, credit and government bonds – becoming relative safe havens: We reinforce our preference for US versus ROW in equities. We think EM equities are more vulnerable to contagion risks from Europe than US equities.

We see US assets across the spectrum – stocks, FX, credit and government bonds – becoming relative safe havens: We reinforce our preference for US versus ROW in equities. We think EM equities are more vulnerable to contagion risks from Europe than US equities.

Statements and actions by central bankers

Elga Bartsch and Chetan Ahya, our global economists, think that in the immediate aftermath of a vote to leave key global central banks will make statements that they stand ready to support markets by providing liquidity and by reopening existing FX swap lines. Such statements could well be coordinated across the G7. Central banks with active QE programmes could make operational adjustments to their asset purchase programmes, if needed. Beyond these emergency measures, however, they do not expect changes in the monetary policy stance in the immediate aftermath of a vote to leave.

Latest posts by David Llewellyn-Smith (see all)


    • lol Not sure if i should be laughing or crying to be honest but it seems like the planet will be up for a rollercoaster ride in the short/medium term !!!!

    • Looking at the analyses of voting, this is a vote you certainly could blame on British boomers at the expense of the young.

      Let the flecks of spittle fly. This time it would be justified at least.

  1. We need clear direction on the AUD. Going back to parity?

    I’m seeing some crazy moves……

      • Because we’re slashing rates with negligible effect. Global economic wheels falling off. New phase of GFC. AUD safe haven currency. I see Brexit as much much bigger event than Lehman.

      • “New phase of GFC. AUD safe haven currency.”

        How did the AUD do during the first phase of the GFC?

      • Yes. We’re still floating around in its wake.

        Rips. Bumps. Froth. Peaks. Troughs.

        More QE ahead

      • and so why is this worse than Lehman? did someone default without telling us?

        no doubt all the chicken littles are salivating at the moment

      • Next week we will see who’s felt the pain from this Jim. Will be very interesting 😉

  2. What markets ? S & P futures were halted down and gold futures halted up. They don’t intend to take any heavy losses, they will turn the machines off until they like what they see.

  3. Stephen Morris

    Economic systems are typically much more resilient than commentators (especially those who are seeking to preserve a status quo – I’m not referring here to the present writer) like to describe. To be sure, great depressions happen but they happen because of a long run build-up of instabilities. These may fail in an avalanche but the underlying instabilities need to be there first.

    If Brexit really does trigger a disaster, then the instability must have been in place well before, and any other event would just as easily have triggered it.

    More likely is that the markets and the economic systems will simply adjust to the new environment.

    A better lesson from Brexit is that sometimes – occasionally – great changes can happen. But it needs people to campaign for them and believe in them.

    If everyone were to adopt HnH’s colleague’s attitude (“that’s all pie-in-the-sky and can never happen”) then indeed it wouldn’t ever happen.

    • Nice piece by Dave Graeber (of “Bullshit Jobs fame) on Brexit and the British economy:


      “In other words, the historical defeat and humiliation of the British working classes is now the island’s primary export product. By organizing the entire economy around the resultant housing bubble, the Tories have ensured that the bulk of the British population is aware, at least on some tacit level, that it is precisely the global appeal of the English class system, up to and including the contemptuous sneer of the Oxbridge graduates in Parliament chuckling over the impending removal of housing benefits, that is also keeping affordable track shoes, beer, and consumer electronics flowing into the country.”

    • If Brexit really does trigger a disaster, then the instability must have been in place well before, and any other event would just as easily have triggered it.

      Well, yes, but any negative outcome that occurs in the immediate future will be deemed to have been directly caused by the Brexit, irresepective of how tenuous the claim may be.

    • Stephen, Please step up, raise the collective consciousness about Direct Democracy & get this country running fair & square! Young Australia is screaming for someone who can sack up & show ’em the way!

  4. What next? who cares I’m just loving this volatility.
    Based on my own results, I hope Germany also votes to leave.

  5. anyone got a detailed analysis on the practical implications of this?

    Not a book, but definitely more than the pretty basic crap that is abound on the internet. Perhaps an accessible briefing paper etc or something.

    Thanks in advance.

    Edit: more specific, technical paper on politico-economic risks, scenarios. (not cultural or purely potical etc)

    • If you find anything specific and authoritative it will be utter bullshit.

      All sorts of madness will/should now ensue. And for good reason. Its not so much like trying to unscramble an egg, but un-melt a nuclear meltdown.

      • “If you find anything specific and authoritative it will be utter bullshit.”

        Exactly! It’s not like there is a precedent either. Only time will tell how this plays out.

    • Yep, the casino will go bonkers for a while but the BOE are not stupid and have the firepower to protect their citizens. The Shenzen thingy will be a question for negotiation along with the muddle of various parts of the treaty, but this will be a progressive exit. Expect Brussels to make it as difficult as possible, but they have none of the awful options they played out to Greece. The PIGGS will be paying attention. Immigration will be a hot topic, but you would expect that as many British were dismayed at the flood of immigrants into the UK allegedly displacing locals. This was a key factor in the vote. Personally, I think the financial markets will adjust accordingly, Everything on the table will be renegotiated in time including the trade agreements.
      This is a slap in the face to the unelected EU Bureaucrats, to Germany and to some extent France who have their own social unrest right now. You could postulate that the UK has regained their absolute sovereign powers and will no longer be dictated to by the Brussels gangsters. IMHO I think overall it will be a good thing for the UK and in particular a glimmer of hope for global democracy. The media are kicking up a storm of bullshit, but what would you expect? I bet the BOE are privately breathing a sigh of relief they didn’t engage in the monetary union. It reminds me of when I chunnelled to Kings Cross and tried to buy a coffee with a Euro (DUH!) which was pushed back at me as though it was a dog turd. This has been brewing for many years.

      • Every problem is an opportunity. Maybe the EU will reflect and strengthen. The exit will be protracted and likely evolve along the way so that the end point won’t be exactly what people thought they voted for.

        You’re right about the media, it’s all just alarmist click bait shit these days. I am not super familiar with that part of the world, but I have watched this whole thing from a distance and its amazing how much has been said of Brexit without anyone actually saying anything of substance… as is the case with most reporting.

        Hence my question.

      • It’s a fair question Adam. I don’t think anyone can reliably predict what will happen because there are so many interdependent actions that can and will be taken by all players. There will be a lot of waffle floating around from the media and “expert” commentators, but the BOE has full sovereign monetary powers to be able to adjust policy as they steer through the process. The social issues will need to be handled carefully and I see Cameron has resigned which I think is a good thing given his partisan position. The trade matters are relatively straight forward and again if cool heads prevail it will be managed in time. Will be required viewing – interesting times.

  6. mine-otour in a china shop

    When do we get the co-ordinated Central Bank support moves – usually the Japanese have the first serve?

    The split of vote by age is telling – the grey army hoisting their little Englander mentality onto their children and grandchildren. When we hit 60 we should lose our vote.

    Sure the British Empire on its own once more will rise again won’t it? Stop the English boats????

    • Not sure the ageism reference is relevant other than those grey voters being old enough to compare between pre EU circumstances. I think the youth will appreciate not having to compete with cheap EU immigrant labour for their jobs. We’ll probably see a return of those displaced youth back to the UK. Best not to listen to the media too much. Hysterics.

  7. life will go on…
    and Australia’s RE market will follow Perth’s into oblivion over the next 24 months >

    • Nah you haven’t been paying attention, the more negative the global outlook the higher Sydney property goes. It’s science bro!

      • If Cameron thinks he can swan around trying to stuff this up until October he is in for a big surprise. The last thing the UK needs now is a lame duck prime minister for 4 months. They will oust him in short time, Boris will already be ringing around for the numbers. Otherwise the economy will stall.

      • Cameron could still punt this to the next parliament, as noted already punters are enjoying the near term volatility, but its a long road to government rubber stamping…

      • He’s resigned Skip, so he won’t be doing much of anything. I’m sure the conservatives from all parties will fight tooth and nail tho, but the people have spoken, so the pollies have been given their instructions. A good time for the left of Labor if they can keep the genie in the bottle. We will all be watching this space. I see the latest estimate is a two year process – sound a bit quick, but I’m a nobody so who knows? Interesting the vote was carried by rural UK but.

      • Lmmaso…. saw that right after I posted, tho that was what I was alluding too… now you have the whole election cycle to go through before anything else..

  8. Cameron resigned because he supported the remain position. Turnbull also supported the remain position. Are we lucky enough for him to emulate? It’s a black day for the conservatives. 🙂

    • Meh, just came through:
      “Prime Minister Malcolm Turnbull said Australia will weather the economic storm from the historic referendum, while Shadow Treasurer Chris Bowen said it was not the time for a scare campaign from the government.”

      We’re stuck with the bastard until July 2.

  9. Gillian Tett made an interesting observation on CNBC w/ Steve Liesman…. too paraphrase … the – Market – got it wrong, traders got it wrong, punters got it wrong and economists ultimately got it wrong, and with it the notion that such devices process information better is now battered and bruised…

    She then had nerve to suggest that maybe some might ask an historian, social psychologist or anthropologist about what happened…

    Disheveled Marsupial…. Blasphemy !!!!!

  10. “Enormous falls in house builder shares” in the UK today, according to Old Mutual Global Investments (Sky News UK).
    Exposing the heart of the Ponzi – beautiful to watch.

    So soothing to the soul to see all the Masters of the Universe with sweaty brows.
    The voice of the people is so powerfully scary to these rogues!

    The governor of the BOE sauntering out of the long corridor to make his press announcemet like he was President of the UK – which he probably thought he was – until today ! What a shock for the poor little rich dude from Canada

  11. Guardian today.
    ” Brexit was a referendum on uncontrolled third world unskilled migration influx being stopped ”

    Brexit is a turning point for the British to regain their sense of identity and control of their country. Past some short term impacts, it can be expected the British economy will revitalise and grow ahead of where it would have been otherwise.

    The first chance the British people had any say on the unwelcome unskilled migrant influx and social burden foisted on them by both parties, they voted against it.

    In Britain the unskilled migrant guestworker influx was running at 350,000 a year with over 3 million guestworkers in 65 million (4.6%) creating housing impacts, lowering wages, destroying the quality of life and introducing large scale crime, vice and blackmarket labor rackets. This was despite controls being put on access and identity enforcement and shutdown of the international student racket with removal of work rights.

    Australia is about one third the size in population at 24 million, but with even higher rates of uncontrolled unskilled migrant inflow.

    We have today onshore 2.39 million migrant guestworkers on fake or pretext temporary visa.
    We have 10% or over 2 times the British issue.

    Unlike the British we have virtually no controls or checks in place. All our temporary visa categories are extensively frauded.
    As example our international student ratio is 28 x the OECD average and it is the laughing stock of the world in sham courses and alibis for blatant migrant labor racketeering.

    Our migrant guestworkers as students or working holiday or tourists or 457 are even more unskilled, more useless, more criminal than what the British have.

    And unlike in Britain, no controls at all.
    Almost all work illegally, fake ID, paying no tax or contribution.

    Our issue given the size of our population is more than 2 times worse than the British.

    Now the UK and the USA as well as Canada all act to secure their borders and protect their citizens standard of living..
    The Muslim and African and Asian migrant racketeers will redivert their flow and labor trafficking into countries like Australia that has virtually no controls.

    We urgently need the same referendum and result here.