We are one week on from the shock waves of the initial market fallout from Brexit, and there are two things we can glean from this week:
- The political picture remains in turmoil.
- Financial markets are moving on from all this.
Leave it to markets to come up with cute verbal mashups. Late last week we say that the market had to face “breality” and already we are hearing that this week is the beginning of the “brecovery.” Markets right now are stable, but need to know how the global economy, and the U.K. in particular, will recoup its momentum. In many ways, the analogies to divorce are apropos -- growing tensions, a big shock, disbelief, and eventually a sense of recovery – albeit in a very different environment.
To have clarity though requires leadership, and that is very unsettled right now in the U.K. While markets await clarity on the political front however, we do have some structure emerging in the financial markets for the medium term.
The new financial order has already determined that rates will stay low. Market expectations of all the major central banks have priced out rate hikes for the year and market expectations for the ECB are for a rate cut (further into negative territory) in the fall. Bank of England Governor Mark Carney said earlier this week that the BOE will most likely deliver some stimulus this summer. Markets are actually pricing this in for mid-July.
Another eye-popping market indicator is the yield on 1-year U.K. government bonds, which broke below 1.00% for the first time in history, and traded down at 0.86% -- almost half of what it was yielding as recently as late April. Low rates across the yield curve only discourage capital inflows into the U.K., just when they could really use them.
My View: The big loser is shaping up to be the British pound sterling, which is back at 1985 lows and looking into another abyss over the next few weeks as investors have little reason to buy the currency. That said, while central bank stimulus will hopefully stave off global recession, the U.K. itself is facing a tough next few months undoubtedly. I do think Britain will ultimately find its way post-E.U., but it will take weeks and months to figure this out.
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