June 2016

• Britain’s decision to exit the EU may constitute the first step on a “stairway to Hell”, throwing up a tangle of economic, financial, societal, legal, political and other issues of unfathomable complexity. The divorce will take years to play out and its consequences are unpredictable, ranging from the destruction of the EU to its exact opposite: a strengthening (more likely). Irrespective of how it evolves – including the remote possibility that it is reversed by a general election and a 2nd referendum or that Article 50 is never invoked -, Brexit is: (1) A major blow to Europe that puts 60 years of integration and expansion into reverse (2) A warning to established political parties across liberal democracies; (3) The expression of a revolt against globalization and austerity.
• Having asserted in February that the Brexit risk was underestimated, we changed our view in May as prediction and betting markets were giving the “remain” camp a 70+% chance of success. Mea culpa! The fact that the markets, experts, politicians and all (including us) got it wrong calls for much humility. This caveat in place, what can we anticipate with a reasonable degree of confidence? (1) Protracted uncertainty (which investors hate) and market volatility, (2) The EU stance vis-à-vis the UK will not be punitive but unforgiving (so as not to encourage others), (3) The EU will do everything it can to prevent financial and political contagion (as it did in 2010 – 2012 when there was a quasi-absolute consensus that the Eurozone would implode), (4) The next UK government risks being overwhelmed by the scalability problems of negotiating the exit terms, dictated by the EU.
• The main economic and market consequences of the Brexit are the following: (1) a much weaker GBP – a stimulative safety valve that won’t prevent deteriorating economic growth and current account deficit, with a UK recession likely as soon as in Q4 of this year; (2) a weaker EUR and a stronger USD; (3) a boost to $ assets in general; (4) a negative shock for European banks; (5) flattening curves for sovereign bonds – with the exception of peripherals; (6) likelihood of a Fed hike in 2016 sharply diminished.

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