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Brexit sends markets correcting wrong guess

Surprise result after opinion polls indicated 'Remain' victory pounds sterling, batters markets
Saturday, June 25, 2016 - 05:50
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Shocked investors pummelled risk assets and pounded the sterling on Friday after Britain's surprise vote to leave the European Union fanned fears of a summer of discontent.

Singapore

SHOCKED investors pummelled risk assets and pounded the sterling on Friday after Britain's surprise vote to leave the European Union fanned fears of a summer of discontent. The reaction was especially pronounced because positions headed into Thursday's referendum were mostly betting against a so-called "Brexit".

Citi noted in a report: "This represents a major surprise as predictions markets had been assigning a 25 per cent likelihood to a 'Leave' win on the morning of June 23, and risk assets had rallied noticeably up until polls closed."

Initial exit polls and early results also suggested a slim victory for the "Remain" camp, before the needle swung in the other direction. CIMB economist Song Seng Wun - who noted heightened risk of credit downgrades for Britain - said the lack of precedence has led to knee-jerk risk shedding.

"Through the morning, I got a bit of assurance when those in Gibraltar voted. But as the day went on, I got a needling feeling that it was not so good," Mr Song said. "The market reaction is very reflective of how people think, which is: we don't know what's going to happen - but let's act first and think later."

Analysts were quick to rattle off lists of concerns: trade, employment, economic growth, political changes, and a renewed call for independence in "Remain"-leaning Scotland. In a report, a bearish BlackRock opined: "We expect the UK divorce to be messy, drawn out and costly. It involves unpacking UK and EU laws, and striking trade deals with a spurned EU and the rest of the world."

Others noted potential political fallout. "The political impact is probably far more important than the economic one, as anti-EU protesters will gain voices in the coming elections (Spain, Italy, Netherlands)," Union Bancaire Privee private banking chief investment officer Norman Villamin said. "The risk is a fragmentation of the EU and the eurozone, and even other anti-EU referendums in some regions."

OCBC economist Selena Ling said that the uncertainty will nevertheless dampen economic growth in the UK, with possible spillover into the EU and other trade partners. Central bank policy will also have to be more accommodative.

As a trade-exposed economy, Singapore might be negatively affected as well, but Ms Ling did not expect the impact to drag Singapore into a full-year recession.

The pound fell sharply, losing more than 10 per cent against the US dollar at one point to scrape US$1.3236. The Japanese yen rose sharply on safe-haven flows, complicating efforts to spur the Japanese economy and raising pressure for more accommodation from the Bank of Japan (BOJ).

"The yen has traded stronger than 100 versus the US dollar in initial reaction," Morgan Stanley noted. "Every one-yen stronger move knocks off around 65 basis points of Topix earnings forecast, and, in our view, consensus estimates even prior to this event were substantially too high. Our FX strategy team is targeting a dollar-yen level of 90-95 by the end of the year from this event."

Equity markets retreated as risk aversion raised its head. In Singapore, the Straits Times Index fell around midday as the final results of the referendum were announced, but clawed back some of the earlier losses to close at 2.735.39, down 58.46 or 2.09 per cent. The Nikkei 225 dropped 7.92 per cent, or 1,286.33 points, to 14,952.02 on the stronger yen, while the FTSE 100 index shed as much as 9 per cent to hit 5,788.74 just after the London markets opened. US stocks plunged at the open on Friday, with the Dow Jones average falling more than 500 points.

Noting that economic fundamentals were already weak to begin with, Brexit will trigger widespread selling of equities, DBS chief investment officer Lim Say Boon said.

"Risk asset markets were already staring at darkened skies in early June, as a result of higher prices amid deteriorating economic and earnings fundamentals," he wrote in a report. "The United Kingdom's decision to leave the European Union will turn this into a perfect storm."

UOB Asset Management said the clouds will need to clear before equities can recover: "It will be increasingly difficult for risk assets to perform until the ongoing issues related to the exit are clarified and evidence shows limited spillover to the global economy."

Gold rallied on a flight to safety. Spot prices for the precious metal rose to US$1,311.11 per ounce as at 5pm on Friday, up about 3 per cent on the day. Oil slipped, with Brent crude futures easing to US$48.81 per barrel.

Government bonds also rose, with the benchmark 10-year Singapore Government Securities yield falling to about 1.91 per cent, a two-month low. The benchmark 10-year Gilt was yielding 1.04 per cent, down 33 basis points, as at 7pm on Friday.

Central banks stood ready to put out any fires.

The Monetary Authority of Singapore (MAS) said interbank money markets were functioning normally, and that the trade-weighted Singapore dollar remained within its policy band despite heightened volatility. Domestic banks were also well on safe ground. "The liquidity positions of the major banks in Singapore are healthy, and overall banking system liquidity remains adequate. MAS will provide additional liquidity to the banking system if needed," it added.

The Bank of England also announced a provision of £250 billion (S$459 billion) in additional funds for market operations to stabilise the markets.

Looking beyond the market reactions, Tharman Shanmugaratnam, Singapore's Deputy Prime Minister & Coordinating Minister for Economic and Social Policies, noted that "there is a new brew in politics around the world".

"The big issues are not about financial markets or economics. The markets will react negatively, and overshoot, but this will not be like 2008 when the house came down. There will be a loss of growth in the UK and Europe because of the uncertainty of the next few years, and the weaknesses there will also hurt the rest of the world including us in Asia," he wrote in a Facebook post.

"But the more profound questions revolve around politics. Many of the people who voted for Britain to leave Europe, like those in England's industrial cities, may end up being hurt by its economic consequences. Yet their frustration over their jobs and wages, and their fear of uncontrolled immigration if Britain stayed in Europe, has shaped their votes."

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