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Brexit Hangover to Last for Two Years – Thank you, British Voters!?

Did you make a killing in the forex market during the late-night Brexit shenanigans? Analysts are already calling it the trading opportunity of the millennium. The British Pound typically ranges from 120 to 150 pips per day, but over the period that lasted from election day until early in the morning, Cable, as it was once called, fell a shocking 1,800 pips before staging a slight comeback to 1.365. This elevator ride bounced along violently during hours on end, making it quite easy to short and fade the night away.

What hath the British citizenry wrought? The quick answer is a ton of uncertainty that will last for years and will become the excuse for everything not working, both on the islands and elsewhere. While the rollercoaster was plunging to the depths, Asian markets were beginning to open. Equities soon took one for the team. Investors with weak hands were heading for the exits, plowing free capital into Gold and U.S. Treasuries and anything else that even resembled a safe haven in the storm. The Euro took a dive, as well, but not nearly as dramatic, while the USD and Yen soared.

Was the hysteria warranted? Probably not, but it was what it was. If there are direct financial impacts from the vote, they will occur far downstream. If economists are correct, and that is not a rhetorical question, then the UK economy will be crippled for the long run. In their own words, “The UK government has estimated that exiting the EU could cause the British economy to shrink by between 3.8 and 7.5 percent by 2030 — depending on how well subsequent negotiations for access to the European market ultimately went.” The EU must now be officially notified, and then a two-year negotiation process gets set in motion, which may become the messiest divorce of the millennium.

Will we still be talking about Brexit fifteen years from now? If this is but the first domino, a concern that many share at the moment, then we may see a “Spexit”, an “Itexit”, a “Frexit”, and maybe even a “Gerexit”, not to mention the Netherlands, Belgium, and a host of others. Are we beginning to see the failure of the latest grand European experiment in cooperation and combination? The seeds of discontent have been planted for some time, but the lack of economic prosperity for a decade has galvanized an angry populace into action. People are hunting for guilty parties like never before, pointing fingers at the incompetence of public officials to create jobs and stem the flow of immigration. In times like these, cultural diversity gets pushed aside for mob rule.

What immediate impacts are likely in the weeks ahead?

Nationalist pride and protectionism have been on the rise in developed countries for quite some time. The anger displayed by the British citizenry is not unique to the British Isles. Scottish secessionists will be emboldened again, as they voted overwhelmingly in favor of staying in the EU. They want none of the economic uncertainty that British hubris has brought to the forefront. The two Irelands want none of it either. Will the Irish in the south suddenly have to renegotiate trade agreements with their northern brethren? Will they now need a passport to visit family in the north?

The first casualty, besides Jo Cox, an MP who was brutally assassinated by an overzealous madman, was David Cameron, the sitting Prime Minister that called for the Brexit referendum back in February. He had hoped to quell the exit debate once and for all, but his tactic seriously misunderstood the anger seething beneath the surface. Even Labour voted heavily for leaving. Officials have noted, “It was all about immigration and jobs and I think we have to look at why that resonated so much.”

One pundit summarized the next steps as follows: “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.”

As for the European continent, every nationalist movement received a jolt of positive endorsement for its cause. European heads of state suddenly convened to discuss the consequences and what the next steps might be. These same officials had already warned British voters and politicians that, “A decision to leave would meet an uncompromisingly firm EC.” They have to make a nasty example of the UK in order to strike fear in the hearts and minds of others that are considering similar referendums.

The truth of the matter is that survey specialists, bookmakers, and our financial markets seriously underestimated the strength of the Brexit supporters. Something broke down somewhere. Our best tools for anticipating the future failed us miserably. We got caught flat footed when Brexit caused, what some have called it, “the biggest global monetary shock since 2008.” We will now have to endure weeks of hindsight reporting, as every pundit proclaims another signal that only he saw coming. Promoters will hype their newsletters as being the only one to forecast correctly the Brexit vote outcome, while others will claim to have made millions with their cleverly programmed robot.

The more immediate problem, however, is that the U.S. Dollar has gone on another strengthening rampage. When the Dollar gets too robust, it immediately puts pressure on those developing economies that must borrow in USD-denominated debt instruments. Since 2000, Euro and Yen-based financing deals have remained fairly stable, but U.S. Dollar-based loans, both to and from U.S. residents, have tripled. The Brexit result that no one anticipated is that these debt holders suddenly owe more money in their national currency than they did before the referendum.

Since 2014, the USD has tightened a noose around the necks of emerging market countries, even China. Chinese officials have tried every trick in the book to slow down the depreciation or at least the realization of the fact that the Renminbi must come down in value. Roughly 40% of the global economy ties its fortunes to the whims of the Dollar, or as one analyst calls it, “the curse of the so-called ‘dollar block’ countries – they import their monetary policy from abroad.” The Brexit “Butterfly Effect” is that a simple yes-or-no vote in the UK has suddenly morphed into a massive shockwave to our global economy.

Could the Brexit outcome become the catalyst for a global liquidity meltdown?

Central bankers have been warning us for years that quantitative easing programs across the planet were twisting market forces into a heavily coiled spring. Either we proceed cautiously by gradually unwinding what central bankers have created, or we risk a horrendous unraveling of market forces in one fell swoop, resulting in a liquidity catastrophe that would make the Great Recession look like a bump in the road. The result of this continuous hand wrangling is that everyone immediately fears the worse when anything like a shock enters their consciousness.

Has Brexit set in motion a chain of events that can only get worse? Doomsayers have already been prevalent for some time, trying to hawk their newsletters and their opinions that the sky is ready to fall. If our best financial tools and market indicators failed to see this oncoming Brexit train, then it could be a real possibility that things could get worse, rather than better. At least, you can feel assured that the Fed will not be raising interest rates anytime soon. But forecasters have also begun to sound the “recession” alarm bells for 2017, suggesting that various economic indicators foretell a slowdown to come.

What are the next steps?

Per one pundit, “It will take 2 years at the very least for the UK to unwind from the EU and during that time the country will remain part of the Union, although one which will effectively have no say in future policies. Prime Minister David Cameron has said he will stand down and wants a replacement to be elected by the ruling Conservative party before its annual conference in October. There will be much political jockeying for positions in a new Cabinet and undoubtedly the opposition parties will call for a general election.” Get ready for a long, drawn out process.

What about financial markets in general and the forex market in particular? Once the dust settles, investors will leave the safety of T-Bills, Gold, and whatever else to grab bargains right and left. Expect a bounce back. Markets did bounce back after Lehman Brothers folded in 2008, recording more than a 10% recovery from the depths of market hysteria. It may now take days for markets to find new equilibriums, worthy of support. The Band-Aid has been ripped away from a festering wound. With fresh air, perhaps, the wound will heal. If others have similar bandages, then time will tell.

Concluding Remarks

Brexit is now a reality. We now have to deal with the hangover. Stock markets may have overreacted to the news. Great Britain is only 4% of global GDP. Even if its economy shrinks a bit, it will hardly be a ripple upstream. Will the ripple become a tsunami? One analyst saw the broader picture: “The markets are likely jumping the gun here. They’re not asking if this is bad for the UK (which it is, though not catastrophic). They’re asking if this is the start of something much bigger – the beginning of the collapse of the EU and the EMU. That’s a real outlier risk and one that should be considered.”

And therein lies the debate going forward. The UK, however, never converted to the Euro. It kept its beloved Pound Sterling. Other attempts at exit would face larger challenges. Emotions in the UK may be running high, and they may be creating a great deal of uncertainty, but no one foresees this single event as one worthy of derailing the global economy. Will the EU experiment crumble? Unless major structural issues are addressed, no one sees it continuing another decade or two.

Twenty years is a long time from a market perspective, as is two years. Get prepared to hear a litany of treaty renegotiation stories, blow by blow – and with each bump in the proceedings, welcome uncertainty, your friend, since with uncertainty, comes volatility, and the opportunity to make money in the foreign exchange market. Stay tuned!

Risk Statement: Trading Foreign Exchange on margin carries a high level of risk and may not be suitable for all investors. The possibility exists that you could lose more than your initial deposit. The high degree of leverage can work against you as well as for you.


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