The British public voted to leave the EU, confounding the pollsters and the politicians. The markets slumped in panic, but our finance expert has his own ideas about what may happen now.
So the Brexit vote happened. Once again the polls were in a pickle and for a change the bookies got it terribly wrong. On the afternoon of the vote, you could have got 14/1 odds on a ‘Leave’ result, which underlines what a huge turn-up the win for ‘Leave’ was.The foreign currency markets got it right, or more accurately priced in a good possibility of a Brexit win. From the moves leading up to the vote, the currency action could be used to roughly calculate a FTSE range of 5,300 to 6,600 depending on the result: 6,600 for a ‘Stay’ vote and 5,300 for a vote to Brexit.
The day after the result, in response to a ‘Leave’ win, the FTSE slumped. The close the evening before the Thursday vote was 6,338; the low on the Friday was 5,778. The EU markets fell heavily and so did the US. Interestingly, the German DAX and the French CAC40 slumped even more than the FTSE. This could be read as suggesting that Europe would suffer more from the separation than the UK, but even so it was an odd outcome.
Perhaps something else was at work, because the FTSE rallied to 6,100 at the close while the CAC in Paris and the DAX in Frankfurt lagged.
After a weekend of rumination and bold headlines, Monday wasn’t a great day for the FTSE and it closed down just below 6,000. Then something odd began to happen. The FTSE rallied and rallied during the week, rising, as they say, ‘like a homesick angel’. By Monday 4 July, it had hit 6,600.
6,600! That’s the level predicted for a ‘Stay’ result. Has the world gone mad? Is the market wrong? Or is the Brexit secretly a dead duck waddling?
As I write, the market is saying that the Brexit won’t happen. How can that be?
This is how the logic runs:
- The referendum is ‘advisory’ and not binding on parliament. The Scottish devolution referendum was mandatory, but this one is not – and that’s not accidental.
- There are 650 MPs in parliament, but only 130 or so are pro-Brexit. That’s not even a majority of Conservatives.
- Parliament is sovereign in this matter. That is why the referendum outcome is advisory.
- Article 50 cannot be invoked without a parliamentary vote.
Ergo: Brexit is dead. That is what the market is telling us. Of course, this is not destiny, only a very high probability trade.
What now follows is a long-?drawn-out political theatre where the political and institutional elite kick Brexit into the long grass. Let’s call it, ‘Project Whoops, No Brexit’. All the field marks are there, slowly unfolding. The clues are:
- Boris Johnson out of the leadership race without a fight.
- A pro-EU PM on the edge of election. Can’t risk a Brexit leader.
- Elder political statesmen urging a prudently slow progression to Brexit.
- Many references to the tightness of the result and the regrets of many Brexit voters.
- Legal moves to enforce a parliamentary vote on Brexit.
Article 50 will not pass a parliamentary vote, and unless there is a leadership prepared to invoke the EU exit clause unlawfully, Brexit is extremely unlikely to happen. Either that or the market is wrong and there is a flaw in the above reasoning.
So what does No Brexit mean? Firstly, it means all the economic benefits that would have been lost from the EU exit are safe. The huge dislocation so feared by business and politicians will fade as fast as the referendum result can be brushed under the carpet. The fat economic haircut likely to be the medium-term cost of a Brexit will be avoided.
That is so long as the politicians can play out their Brexit sabotage without setting the electorate ablaze with anger.
Secession and baulked secession is an incendiary configuration. We can throw away all our stock charts and economic models along with the referendum, if Westminster fails to navigate the coming months with sufficient unction.
Let’s be clear: killing the Brexit will be a terribly dangerous course. Brexit is already a ‘black swan’ event and any kind of serious mishandling of it could create a political and economic ‘Minsky moment’ where great value is destroyed because the stability of the past and present is overestimated and the fragility of the future underestimated. However, I think the politicians will pull it off. After all, their core skill is to prestidigitate.
Meanwhile, there will be hedging. A binned Brexit is not a slam-dunk certainty and as such all players will be hedging, unlike myself in this article. This means gold and precious metals will be strong and the pound will be weak.
A weak pound will be great for industry and may well cause the inflation that has been so allegedly hard to make.
The UK is already using quantitative easing (QE) and the EU has been on that trip for many months; it will further let out its purse strings to put a financial crash-mat under the economies of its members, just in case the UK does actually pull the ripcord on its EU parachute. This money will slosh about and drive the stock market higher, and the low pound will give the UK an economic boost.
The Conservatives might end up looking good by the time of the next election on the proceeds of this stimulation, so it’s win-win for them.
Quantitative easing is often seen as printing money, but it isn’t. QE is buying illiquid assets at a premium, for cash. This cash must then find a home in ‘productive’ assets. The cash goes into the economy and mostly ends up in financial instruments like the shares of dividend-paying companies, or other such financial engineering products like commodities futures and even mortgages. These emergency funds will thereby push up oil prices and the share prices of the FTSE’s big companies.
As I write, the Bank of England has already pushed nearly £3bn of cash into the system and it will continue to be on guard to catch any falls in the market resulting from the politics of Brexit.
With no Brexit and with more QE, lower interest rates and a flattened pound, what’s not to love about that situation for UK engineers and manufacturers?
If Brexit happens, it will be a revolution for Britain. Societies and economies often flower after tumultuous times, but during the storm of change, the costs and casualties are high.