UK Vote a Sideshow For Markets…

‘Even if the UK votes to leave and begins the prolonged legal and political process of exiting, the comparisons with Lehman as a broader economic shock look very overblown as is any imminent prospect of wider EU/EMU contagion led breakup. This would be a messy, acrimonious divorce which would adversely impact UK growth/funding costs over the next couple of years, but no major economic shock for Europe, with an exit vote likely forcing EU reforms and a narrower but much deeper level of integration, notably via the banking system (deposit guarantees etc.). A kneejerk FTSE 100 selloff in that scenario would be a buying opportunity given the earnings boost from sterling for resources, pharma etc.’ Macro Weekly, 17th June

And so it has proven; we have closed the longstanding GBP short on twin deficit funding risks (initiated in mid-2014), the long JPYUSD position from last summer and the long VIX position from April into the post Brexit turmoil, as this always looked less like a Lehman than non-event for global markets. It was striking that our  non-consensus overweight on emerging markets/commodities remained resilient through the initial selloff and global investors remain very underweight both the FTSE 100 and EM, despite clear signs that net earnings revisions are improving rapidly (and about to turn positive in the UK).

The UK stumbled into what I termed in recent months an ‘accidental Brexit’ thanks to weak turnout among young voters and astonishing political incompetence in both calling the referendum in the first place and them mismanaging the campaign. This is now widely seen as a howl of provincial protest expressing popular anger at the London elite, reflecting the global inequality narrative, but anti-immigration sentiment was a key factor.

Most ‘leave’ voters were under the delusion that inward migration from the EU would suddenly stop, when free movement will be central to newly negotiated trade deals. The political atmosphere will become even more strained when the reality dawns that the referendum ‘taking back our country’ soundbites are simply unenforceable in practical border control terms. Importantly, the UK is an outlier in terms of Euroscepticism; no other EU electorate is likely to vote to leave the EU (or be offered the chance). Indeed, the Spanish election at the weekend saw the ‘rejectionist’ Podemas movement lose share to the centrist pro EU parties of left and right. The EU is now likely headed belatedly for a ‘two tier’ structure of a far more Federalist core of 5-7 nations that drive decision making led by Germany and an ‘EU lite’ membership for the rest.

European banks have been hard hit by the referendum shock driving a further rise in the proportion of negatively yielding Eurozone bonds . The key to a sustained sector rally remains Italy – the badly designed new stricter EU ‘bail in’ rules created a crisis of confidence in Italian banks and allowing a more decisive recapitalisation is now critical to creating a moat around the Eurozone economy.

A much more flexible German attitude looks likely to be forthcoming shortly, as Italy has to be a member of a new core Europe political arrangement. Substantive recapitalisation of Italian banks (€40bn plus) would trigger a risk rally far beyond Eurozone banks – the ‘pain trade’ for  global investors terrified of and positioned for a seemingly endless list of macro tail risks remains further risk asset performance in H2.