Brexit - A Storm In A Tea Cup?
So what happens now?
Markets
The implications of the referendum will become clear in stages. In the immediate term, markets will react negatively to the results, and global markets have already tumbled into the red. The pound has fallen by over 10 percent against the dollar and is on track for its worst single-day decline in 45 years. Outside the United Kingdom, emerging market currencies and oil prices are also dropping, and stock exchanges around the world are likely to follow, with money moving into havens such as the Japanese yen and gold. In recent days, markets had reacted optimistically to opinion polls saying the "remain" campaign would prevail. This suggests that their reaction in the coming days could be particularly hard. Japan's Nikkei index, for example, has already suffered its worst single-day fall since the Fukushima incident in 2011 and it is expected that the FTSE 100 could drop by as much as 8.8%, which would be the third worst decline in history. Scary stuff!
Banks will be the most hit, as we have a long period of uncertainty ahead with questions on how much will this affect the U.K. economy and whether there will be copy-cats in the rest of Europe. Depending on the depth of the negative market reactions, the European Central Bank (ECB) and the Bank of England will have to activate emergency agreements (such as a swap operation between pounds and euros to provide liquidity to banks) discussed in recent weeks. The ECB is meeting later on June 24 to discuss its next moves. The United Kingdom has a high chance of plunging into a recession, putting the Bank of England in an incredible bind: Cutting interest rates in an attempt to mitigate the risk of recession would hurt its currency even more, creating inflation concerns. But raising them to support the pound will choke off growth. Thus, the coming days will be marked by uncertainty, which will affect financial and economic decisions by investors and households around the world. Bond yields in the eurozone periphery are also likely to increase as investors move to havens such as Germany. Depending on the pressure on those countries, the ECB's promise to do "whatever it takes" to protect the eurozone by intervening on debt markets will be tested.
Politics
From a political point of view, the referendum has already lead to the resignation of British Prime Minister David Cameron, who campaigned heavily for his country to remain in the European Union. Considering the frictions among the ruling Conservatives (roughly half the party's lawmakers supported the "leave" camp), new elections before the end of the year in Britain are a given and in the event that a Brexiteer takes over as leader of the Tory party and as prime minister, he or she is likely to argue that Article 50 is biased against the interests of a country leaving the EU. Under Article 50, the terms of Britain’s departure would be agreed by the other 27 EU countries, without a British vote. So Brexiteers would prefer to negotiate informally, without invoking Article 50. The other 27 countries are unlikely to go for this. The kind of deal offered is a longer-term question, with neither main option very palatable. The first is to become like Norway, which is a member of the European Economic Area (EEA), in return for which it is required to contribute to the EU’s budget and allow the free movement of people. The second is to opt out entirely, trading with the EU under the rules of the World Trade Organisation like America, China or any other country. Most economists agree that this would do more damage to the British economy. Either way, the next leader will have to deal with a deeply divided party and with a Parliament whose MPs mostly supported Remain, and some of whom may want to block approval of full economic secession. In addition, the results will also reignite independence demands in Scotland and, to a lesser degree, Northern Ireland.
The referendum is not legally binding, which means the British Parliament could technically decide not to respect its outcome — though this would mean ignoring a vote in which more than 33 million citizens participated. The evolution of political events in the United Kingdom will determine when negotiations between London and Brussels over the withdrawal begin. According to EU treaties, countries that want to leave the bloc have to formally notify Brussels of their intentions, but the exact moment of the announcement is decided by the country in question. Members of the "leave" camp have said that there is no need to make such an announcement immediately and that London and Brussels should be allowed some time to negotiate informally.
The formal declaration of the intention to leave will trigger a two-year negotiation period, during which the United Kingdom and the rest of the member states will hammer out the terms of the divorce and the framework of their new relationship. It is worth keeping in mind that, while negotiations are taking place, the United Kingdom will remain a full member of the European Union. The free movement of goods, services, capital and people between Britain and the Continent should remain unchanged until at least mid-2018. Any agreements between London and Brussels will then have to be ratified by EU member states as well as the EU and British parliaments. This could further delay the exit process. In an event this unprecedented, those with a seat at the negotiating table will decide how to proceed based primarily on their interests, regardless of what the EU treaties say.
Impact on EU
The United Kingdom will be intent on preserving its access to the EU common market, since roughly 45 percent of British exports go to EU countries and 53 percent of its imports come from the bloc. The United Kingdom's trade access will, however, need to be negotiated. The scope and depth of Britain's access to the common market will determine the extent to which the country will have to comply with EU regulations. Once EU norms are no longer enforced, the British Parliament will have to reintroduce, amend or abolish its laws currently in place. London and Brussels will also have to negotiate over the status of EU citizens living in the United Kingdom and British citizens living in the EU states.
EU leaders will probably strike a hopeful tone about the future of the Continental bloc. In the coming days, member states led by Germany and France will send messages of unity and even portray the vote as an opportunity to continue with the process of Continental integration. But the British vote is the most dramatic event in a long process of political fragmentation in the European Union. Euroskeptic parties across the Continent will present Britain as an example to follow and, depending on the depth of the economic impact on the United Kingdom, their moderate rivals will be underpressure to make similar proposals. One of the most critical countries to watch in this regard is France, which faces elections in 2017 and whose main Euroskeptic party, the National Front, is already calling for a similar referendum. With Britain preparing its exit, the more France drifts from the core, the quicker the foundation of the European Union crumbles.
Over the longer term, the main effect of the British referendum will be geopolitical. Without Britain, the European Union will be missing a liberal, market-friendly member, potentially shifting the balance of power in the bloc to the more protectionist economies in the south. This could exacerbate tension between Northern and Southern Europe, which are already at odds over issues such as the Schengen Agreement and the management of the eurozone. A European Union without the United Kingdom will also be less relevant at the international level, as the bloc is about to lose one of its few members that has a true global presence militarily, diplomatically and economically. By the time London and Brussels end the negotiations over their disconnection, the Continental bloc will look very different from how it looks today.
Impact on South Africa
According to data compiled by Bloomberg, South Africa’s currency has the most volatile among 24 emerging-market peers. The rand has posted losses against the dollar ranging from 5.5% to 8.5% this morning. EUR/ZAR is more subdued, up only 2%, while GBP/ZAR has dropped 4%. These losses might only be the start. Expect an extremely volatile day ahead. Some global banks are even suggesting 20% losses across some equity markets! Meanwhile, South African bonds fell the most since December, with yields on benchmark rand bonds due December 2026 climbing 34 basis points to 9.23 percent, the highest on a closing basis since June. Questions that traders are now asking are what implications this has for the Fed hiking cycle and inflows for EMs. The R186s are currently trading at 9.13/9.09 so there is some bidding interest. At the moment we are nowhere near the volatility that we saw during Nenegate. In the primary market, National Treasury will be looking to raise R650m across the I2033, I2046 and I2050 strip of bonds, however bidding in the weekly auction is likely to be poor, with yields clearing above mark-to-market.
Bottom Line
Expect the next week or two to see extreme volatility, negative headlines from the UK and political rumblings in Europe. But nothing will change and the markets will eventually calm down. Keep in mind events
such as Y2K, 9/11, the subprime crisis. These all lead to volatility, but the key is to wait it out and not trade on emotion.
Source: Bloomberg, Stratfor, The Economist
