First indication of the price of Brexit

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Kim Asger Olsen

Kim Asger Olsen


While the Brexit may be quietly be negotiated, the economic effects begin to be visible.

In the past weeks I have come to suffer a Chronic Brexit Syndrome, coming from a heavy OD of crowing Brexiteers, who still do not understand what they have unleashed. Brexit is not going to go away soon, but EU and the UK appear to coalesce in containing the crisis. Fortunately Brexit has all but disappeared from the headlines.

The ability of EU to compromise will very likely lead to some kind of horse trade arrangement whereby the UK negotiates the right to remain inside the European Economic Area, and will probably be offered a limited time period to experiment with various models to curtail immigration.

In two years’ time it will be made clear to the UK electorate how much the EU membership cost before and after the changes, and I am willing to bet that the UK electorate will be asked again, this time on the basis of a serious information campaign.

So please, can we put this aside for now? One thing was proved beyond reasonable doubt: A referendum is a dangerous thing for the democracy, because voters can be swayed by demagogues and other liars. Voters are tired of politicians, but do not see that for every superficial and popular charlatan like UK’s Boris Johnson or Italy’s Beppe Grillo, there are about a 100 diligent parliamentarians who actually work to obtain a detailed knowledge of the issues in order to be able to make informed decisions.

A big cheer for the representative democracy.

While the powers that be have all interests in containing the political fall-out, the financial markets are beginning to focus more on the actual impact on the UK and the European economies. That kind of things takes some time to filter through to the economy, with the economic expectations being the driver of short term changes. For quite some time the so-called Flash PMI indicators have been the earliest indicators. The first report for the UK after the referendum came out on Friday and the headline was simple: UK economy contracts at steepest page since early-2009. Ouch.

The same report for the Eurozone was published at the same time and pointed to nearly unchanged, if unexciting, economic growth. The indicators for economic surprises are close to zero, telling that there are no immediate surprises out there.

And in the US, manufacturing (less than 10% of the US economy) rose sharply In July. At the same time economic surprises are increasing strongly.

If these trends continue, we are likely to be in for some important shifts in the financial markets. It seems premature that UK stock markets recovered, particularly since Sterling also strengthened, erasing some of the export advantages of the previous fall.

Strong economic activity in the US will bring rate hikes back on the agenda for Federal Reserve. Rate hikes had otherwise been priced out of the market until early 2017.

In the near term, rate hike increases are already being priced into the market, leading the two year spreads over the Euro-zone to widen. The dollar has strengthened as a result.

So we are looking at the end of the post-Brexit stock market rally, a strengthening of the USD, a weaker GBP and it is worthwhile to keep an eye on long term (15y+) in both the US and in Europe. The long rally may well see a hiccup soon.