Markets: Brexit – the path of uncertainty

Market analysis - 6/27/2016

Long-term political uncertainty should fuel risk aversion among investors. Once again, the initial focus will be on monetary policy rather than budgetary measures.

The shock wave created by the Brexit vote has diminished investors' appetite for risky assets: global equity markets shed an estimated USD 2.080 trillion on Friday alone, according to Standard & Poor's.

The initial surprise is now likely to give way to a period of political transition marked by a high level of uncertainty on the financial markets. The UK is in no hurry to invoke Article 50 of the Lisbon Treaty, which sets the terms for withdrawing from the European Union. David Cameron has announced his resignation, effectively leaving it to the next prime minister, come October, to handle the difficult negotiations with the 27 remaining member states. The negotiations could be further complicated or even blocked if any new agreements require the approval of the House of Commons, where 463 of the 650 MPs are against leaving the EU. The possible secession of Scotland adds to the intrigue.

Euro Zone countries will have to maintain a unified political discourse for the European project to remain viable and for the growth outlook to remain stable. Yet a wide range of views on how the negotiations should be handled have already been aired. And domestic politics in various member states will only complicate the mix. Over the next two years Eurosceptics and their demands will be an issue in key elections in France, Germany and the Netherlands. And the election in Spain last weekend highlighted a number of sticky issues, such as the challenge of coalition-forming, compliance with the budgetary measures recommended by the European Commission, and sovereign debt in peripheral countries.

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Given the political uncertainty and the challenge of coordinating fiscal policy, central banks are very likely to have to step into the breach. The Bank of England, the European Central Bank, the Bank of Japan and even the Fed will all engage in monetary creation until governments come up with appropriate budgetary measures. The low interest-rate environment is set to last for a while.

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