Political turmoil in the U.K. continues as predicted in a previous blog post. Until the Conservatives choose a new leader in early September, who is going to lead the Brexit negotiations and with what mandate and authority? It is at this time that we would expect Article 50 to be invoked, starting the formal negotiations on Britain’s exit. Meanwhile, the labour party may also be choosing a new leader.
The situation remains very fluid in that voters are beginning to get a peek into what a post-EU Britain might look like. The pound (GBP) fell 12.5% against the USD in the two trading days after the vote. The U.K. sovereign credit rating has been slashed by the rating agencies, increasing future borrowing costs, and a number of banks have already announced layoffs and transfers to the continent. The scare mongers that the “Leave” campaign was decrying and discrediting may in the end have just been a warning shot.
As the weeks and months pass, more revelations will become apparent about the reality of a Brexit and the political direction of the nation. All of which might have an ultimate influence on the Brexit project that will be ridiculously complex to negotiate. Already some are canvassing for a second referendum.
The reason the political landscape might alter in the weeks and months to come is that traditional labour strongholds voted in favour of leaving, under the notion that the EU is a capitalistic project and that a “Leave” vote would see more investment in the National Health Service (NHS) with more resources devoted to social issues.
This is diametrically opposed to the conservative “leavers” and UK Independence Party (UKIP) that see the EU as a socialist plot that sucks away the entrepreneurial and creative energy of hard working Brits. Leaving the EU will allow the U.K. to unleash its full potential through free trade. Many on the “Leave” campaign previously called for the privatization of the NHS. Both of these perceptions cannot be right and one constituency will be sorely disappointed. It is not clear at this time which one is right because an election could change everything.
What all “Leave” voters appear to agree on is that immigration is the problem. So it was rather perplexing to hear Boris Johnson, the most likely candidate to succeed David Cameron as Prime Minister, claim after winning that EU nationals would continue to move and work freely in the U.K. That was not the message in the days before the vote.
So this is a fluid and very uncertain situation that will keep markets wondering and occasionally pausing as to how this is going to unfold. The likelihood of a general election in the next two years appears high as it would provide clarity on the way forward.
The biggest concern going forward is Europe and the impact of the Brexit on politics there.
What every politician understands is that a referendum to leave the EU in any given European country would have a reasonable probability of a result similar to that of the U.K.
So how will Europe deal with Brexit? The sensible approach would be for Europe to rethink many of its institutions and how they are working for the individual countries and their citizens, in essence addressing some of the Brexit campaigners concerns.
The other major issue brewing is a banking crisis in Italy. The Italian banking system requires upwards of 40 billion euros in capital as they are weighed down by 360 billion euros of non-performing loans. The EU rejected the Italian government’s proposal for a bad bank a few months ago, but this must be addressed or Italy could enter a full-scale banking crisis that would have a contagion effect onto the rest of Europe.
Europe’s communication and actions on these fronts are critical to re-establishing confidence in the European project and its ongoing sustainability.
But there are questions around the political will as well as political flexibility of individual European states in light of the growing populist parties throughout Europe. Many, who have been emboldened by the U.K. results, will push for a referendum of their own.
The situation demands leadership and the strongest leader with economic weight, Chancellor Angela Merkel, is weakened from her miscalculations on the migrant crisis. A lack of leadership at a time it is most needed may be the biggest risk going forward.
There are some hopeful signs. The Spanish general election this past weekend was a win for the traditional parties. Spain’s populist party Podemos did not make gains.
The euro fell against the USD but remained above recent lows.
It appears Italy will be able to bail out its banks but this still needs to be confirmed.
The backdrop to all of this is that globalization remains under threat by populist parties. How the U.K. evolves over the coming months and how Europe deals with Brexit, and its institutions, will either see a slow down or an acceleration of this process with global implications.
Markets dislike uncertainty and the Brexit result has raised the uncertainty level at a time when growth is moderate at best.
At Signature, we continue to be positioned defensively given the lack of clarity on these issues.
We were relatively well positioned for the Brexit vote and some of the dollar exposures have been pared back since the results. We maintain our gold exposures in anticipation of more non-conventional monetary and possible fiscal policy, something which looks increasingly likely.