The vote to leave the EU is the start, not the end, of a process that could take up to a decade or more, says Marie Owens Thomsen (pictured), Chief Economist at Indosuez Wealth Management, Credit Agricole’s private banking arm.
“In addition to the detrimental effects of prolonged uncertainty and the opportunity cost of spending time and money on these negotiations instead of more pro-growth policies, one can expect the UK financial industry, car manufacturers, and farmers to be particularly hurt, at least until a new framework emerges for the UK, in 2019 at best,” she says. “The EU and all its remaining members, especially Ireland, will also lose out: the other member countries will have to pay the UK contribution (if no solution similar to Norway and Switzerland); the EU will lose cohesion; and lose internal opposition – the UK has been an important initiator of reform within the EU.”
Owens Thomsen can see a UK recession. but no global recession. “The UK will import inflation through the weaker currency,” she says. “The current account deficit will worsen because imports will become more expensive and services exports – the one UK strength – will suffer.
“Hence, the UK will likely revert to a state similar to that prior to the 1973 accession to the European Union, with a diminished role in the world economy and trade, and a heightened risk of balance of payments crises.
“The world is not exposed to the UK as it was to subprime debt. There is no reason to assume a global shock to the business cycle.
“Central banks are likely to adopt 2008 style policies which should make this market correction the best buying opportunity since 2009.
“Hence, near-term, the exit is a buying opportunity for extra-UK markets. Longer term it suggests lower potential growth rates and a more difficult political context than if the UK had opted to Remain.
So what does this mean for the Fed/US/Gold?
“We now change our call on the Fed and no longer expect a rate hike in July and possibly not before the end of the year. However, we do not expect a rate cut in the US,” says Owens Thomsen. “It is possible that other central banks will cut rates, and that those with negative policy rates will move deeper into negative terrain. Negative rates are also likely to be extended to affect more of banks’ reserves.
“Given that the global business cycle is now positive, with some 3 per cent global GDP growth y/y (PPP), these exceptionally accommodative monetary policies are more inflationary today than in 2008.”
According to Owens Thomsen, this makes gold particularly attractive as a safe-haven.
“Gold had already broken its bear trend on stronger demand in the face of slowing supply growth, and we had USD 1350/oz as a target.
“The UK exit adds to this positive momentum and if the USD 1350-1360/oz level is broken through, we will be looking for USD 1400/oz as the next target.
And the implications for FX?
Sterling is obviously the biggest loser in the wake of the exit vote, according to Owens Thomsen.
“The euro too could suffer in the current context and if the ECB cuts rates again; the next meeting is 21 July. The Bank of Japan meets on 29 July and would likely cut rates. The Swiss National Bank meets quarterly but can move at any point in time.
“Regarding the euro, one should not forget that the euro zone is ultra-competitive, running a current account surplus of 3 per cent of GDP, and the European Union actually has the world's largest current account surplus in US dollar terms, ahead of that of China. It will only be larger now that the UK deficit will be excluded.
“US dollar strength will be limited by the lower likelihood of Fed rate hikes, and by the current account deficit which is the largest in the world in US dollar terms, although a rather modest 2.6 per cent of US GDP.
“The Mexican peso has become synonymous with "hedge against everything", and short positions have been building up ahead of the UK vote as well as in anticipation of the US presidential elections where Mexico is seen to suffer the most should Donald Trump capture the White House.”
With the more accommodative monetary policies around the globe, Thomsen believes the dynamics for bonds are now less bearish.
“We used to highlight the fragility in the short end of the US yield curve but that now looks less acute.
There is in this context still value in bond markets, but the relative value with respect to equity markets has arguably dropped – making equity more attractive versus bonds as bond yields fall.
UK bonds will arguably rally (prices rise, yields fall).
“Other bond markets are likely to follow a similar pattern.
“There is an argument for global yield convergence beyond the risk-off mode that will likely favour safe-havens, as investors will chase yield further afield.”
“Along with the UK market, the Swiss and Japanese markets will also suffer from the appreciation of the latter two countries’ currencies. That appreciation is unlikely to cause a recession in those two countries but since the stock market indices are heavily weighted in exporting companies the impact on the stock markets is greater.
“The more accommodative monetary policy stance will be supportive for stocks outside of the UK.
As the world is not exposed to the UK as it was to subprime debt, the UK leave vote is unlikely to have a major impact on the global business cycle, although the UK could well suffer a bout of stagflation.
“In this way, the aftermath of the Leave outcome could represent the best buying opportunity of markets outside of the UK since 2009.
“In our Discretionary Portfolio Management we are currently neutral in our exposure to risk assets, and will monitor developments and spill-over effects before taking any further action.
