Brexit Sends Shock Waves Through Global Capital Markets

Brexit, Sends, Shock Waves, Through, Global, Capital Markets, Fundamental Analysis, fx trader, forex

24 Jun 2016

The UK's decision to leave the EU spurred a dramatic risk-off move through the capital markets. The dollar, yen, and gold soared. Equities and emerging market assets sold off hard. Core bond yields fell sharply.

The main gist of the dramatic price action is to reduce risk. The dollar and yen are the main beneficiaries. Core bonds have rallied, as has gold. Equities, commodities, emerging markets have been hard hit. Since sterling's low was reached in the middle of the Asian session near $1.3230, it has recovered to $1.40. The price action remains choppy and volatile. The euro reached a low a little below $1.0915 and recovered to almost $1.12 before coming back off. The dollar was driven to JPY99.00 and has recovered through JPY103.00.

In the EM space, the South African and Polish zloty is leading the move with 4.2%-4.4% declines. Besides the pegged Hong Kong dollar, the Thai baht and Chinese yuan did best, losing 0.5% against the dollar.  Core bonds, including UK gilts, have seen yields tumble, while peripheral European bond yields are 8-13 bp higher. One implication is that the peripheral premiums over Germany have widened dramatically.   

The MSCI Asia-Pacific Index fell 4%, while the MSCI Emerging Market equity index is off 3% before Latam markets open. Dow Jones Stoxx 600 in Europe is off 6.6%, with financials being tagged with a nearly 10% decline. The FTSE 100 is off 4.6% with health care is the only sector even a slight gain. The UK financial sector is off 11%.

Sterling had initially rallied to poke through the $1.50 level for the first time since last years. As it became evident that the Brexit was going to win, sterling crashed to $1.3230 before stabilizing.  

As the results became official, the capital markets began stabilizing. The Swiss National Bank and the Danish central bank have intervened and remain active, according to reports. On the other hand, the BOJ does not appear to have intervened, though the yen soared. The dollar plummeted to JPY99.00 before rebounding to a little beyond JPY103.

Investors and policy makers are contemplating the implications. They are far-reaching. What we know is that Prime Minister Cameron will step down by October. He will trigger the now-famous Article 50 that begins the formal two-year negotiating period. That responsibility will fall to his successor. There are three candidates that have been touted: Johnson, the former Mayor of London, Gove, the Justice Minister, and May the Home Secretary. Johnson appears to be the early and strong favorite.

The victory for Brexit emboldens the nationalist forces in the other countries. For example, in France and Italy, nationalist parties are calling for their own referendum. Scotland is in the difficult position. Although it is fiercely pro-Europe, the turn-over was lighter than expected, and there will be pressure to have another referendum to leave the UK. Previously, the EU particularly encouraging the Scottish independence in part to prevent precedent for other.