BREXIT: MAJOR CENTRAL BANKS EXPECTED TO ACT
We expect – and hope for – a robust and rapid response from Eurozone governments reaffirming their political unity and commitment to the integrity of the Eurozone.
The British people have voted to leave the European Union (EU). While this decision is a historically significant event, the days and weeks to come will be equally important, as they will provide more information about managing the change, both from the UK and the EU sides.
First, the referendum decision needs to be ratified by both Houses of Parliament. While we still need confirmation on that front, it is extremely likely that they will respect democratic wishes. The second important consideration will be the reaction of the Eurozone itself. Indeed, the resulting uncertainty may throw into question the integrity of the Eurozone and inspire more Eurosceptic movements in other European countries.
We expect – and hope for – a robust and rapid response from Eurozone governments reaffirming their political unity and commitment to the integrity of the Eurozone. However, if Eurozone governments show discord or disunity, investors may start questioning the foundations of the Eurozone, or even of the European Union itself, at a politically sensitive time (Spanish elections on June 26, Italian referendum in October, rising Eurosceptic voices in Austria and Netherlands, continued Greek vulnerability). In any case, we expect the major central banks to act in a concerted way to avoid market disruption.
What should be expected in terms of market impact?
First and foremost, the confidence shock will lead to a global risk-off episode, with US assets outperforming European ones. In the absence of a strong political commitment in the coming days, a prolonged period of uncertainty regarding the future of the European construction should increase the risk premium of European assets. Within the European markets, the repricing of the country risks could lead to more differentiation between the northern and southern Europe, with interest rates diverging again.
In equities, the rise in risk premium will affect European indices for an extended period of time, especially peripheral countries. Taking into account recent market moves, the sell-off may fall between -10 and -15% on the Euro Stoxx 50 (2600-2750) and FTSE 100 (5400-5700), compared with -10% on the S&P 500 (around 1880).
As for bond markets, we expect a widening of peripheral and investment grade spreads (around 50 basis points), with the move somewhat contained, thanks to European Central Bank (ECB) action.
The foreign exchange market currently points to a 8% fall in sterling (GBP) against the US dollar (USD), 5% vs euro (EUR) and 7% vs the Swiss franc (CHF). We expect GBP to fall 8-13% against the USD and CHF, 2-7% against the EUR. Emerging market (EM) currencies could weaken slightly against USD (-2% to -3%), but reduced expectations of an interest rate hike in the US will limit the downside.
Again, central banks will do as much as possible to provide markets with liquidity. We also expect the Swiss National Bank (SNB) to intervene in order to limit the appreciation of the Swiss Franc, especially against the Euro.
It is worth mentioning that these estimates are likely to materialise over the next few days. Yet, we cannot exclude a scenario where, in the meantime, the Eurozone proves politically unified and concerns about its survival subside.
Such a scenario would drastically modify the market impacts of this referendum and these estimates will have to be updated accordingly. At time of writing, a 8% fall is already priced into the FTSE 100 futures market (about -11.5% on Euro Stoxx 50), while the Nikkei is down 8%. However, we will need to see how European markets react before making further investment decisions.
Source of all market data: Bloomberg 24 June 2016
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