Brexit: the seismic shock has subsided, what now?

Britain is outThe initial Brexit shock to markets has subsided and liquid asset prices have rapidly adjusted to the new reality. In general there has been a flight to safe haven assets whereas investments most directly exposed to the UK economy have suffered falls, in some cases substantial. However, market moves so far have been less violent than many doomsters’ predictions ahead of the poll and there are few if any signs of a market crisis, global contagion or systemic drying up of liquidity. Other than in the immediate post poll trading, when some UK stocks and European financials fell precipitously, the market reaction is typical of moves following a shock outcome to a key decision, which in the case of the UK referendum was regarded by many commentators as globally significant.

Currency markets have seen the most dramatic moves, with sterling falling sharply as investors fear long term deterioration in the UK’s trade account and foreign investment flows. Against the US dollar, sterling immediately fell from $1.49 ahead of the poll to around $1.32, a drop of over 11% to a 31 year low. It has subsequently recovered modestly as markets regain a degree of stability, but remains at $1.34. The pound fell somewhat less against the euro, by about 8%, but by an extraordinary 15% versus the yen, which is seen as a safe haven in periods of market stress.  Gold rose by 5% to $1,324 which translates to a 19% rise in sterling terms.
Equity markets fell, with the heaviest losses in UK domestic stocks, best represented by the FTSE 250 index, down by 14% in the two days after the poll, as well as financials across Europe.  In fact European stocks suffered generally, with the MSCI Europe ex UK index down by close to 10%. In contrast, the index of leading stocks in the UK, FTSE 100, fell by a relatively modest 5.6% and has since recovered all the ground lost; it has been substantially protected by the dominance of companies which derive most of their revenues and profits outside the UK. Many of these stocks have moved to new all-time highs. The S&P 500 also fell initially by 5% but has subsequently recovered most of the ground lost.
Bond markets reacted broadly consistently with any ‘risk off’ period. Government bond yields fell significantly, by about 20bps in Germany, 30bps in the US and 45bps in the UK. As well as attracting safe haven funds they also discounted slower growth, especially in the UK and Europe and the likelihood that central banks everywhere, but most importantly the US Federal Reserve (Fed), will defer any interest rate rise for a considerable time in the face of a new threat to growth and stability. In the case of the UK there is now no prospect of an interest rate rise for several years ahead, indeed there is a much greater chance of a rate cut to zero (but not into negative territory, the Bank of England remains unconvinced of the merits of such a move).
What next? In a febrile political atmosphere in the UK and Europe, and with high levels of uncertainty surrounding the implications of Brexit for the UK and the EU we provide the following perspective:

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