On the 23rd of June, the citizens of Great Britain have expressed themselves regarding their presence in the European Union (EU). The referendum outcome was shocked for many and to all markets, be it currency, equity, debt, and commodity, reacted with volatility.
Most commodity prices were sent tumbling on Friday following surprise British vote to leave the European Union, but gold benefitted from a flight to safety. Oil prices fell about 5 percent in New York’s morning trade on Friday.
The dollar index jumped 2 percent, its most in a day since October 2008, while sterling collapsed to a 31-year low after British Prime Minister David Cameron, who campaigned to remain in the EU, said he would stand down by October.
Most of the Asian equity markets were down by 2-3% except Japan closing 7.92% down. The European markets were bleeding with 6-12% cut though FTSE 100 was down by only 3.15%. The US markets also reacted negatively were down by 3-4%.
The US 10 years bond yield is down by 16 bps (-9.12%) currently quoting at 1.572%.
The initial reactions are generally a little overboard but at the same time we don’t have any parallel to Brexit. It is important to note this is not a black swan event; it is more of a politico-economic crisis than a financial crisis like Lehman brothers. In 2008 “it was fear about the collapse of the financial system,’’ and this time “it is more about the impact on the longer-term global growth outlook.’’
What Brexit mean?
- Currency dislocation – None. The UK doesn’t use Euro.
- Trade dislocation – Probably not. Free trade can continue with the UK outside of EU, but it would be more bilateral agreements.
- Human dislocation – None. The pro-Brexit crowd is also pro work visas, and implementation is decided by the Parliament.
Stress Test your Portfolio Now
- Keep your eyes on Interest Rate: The Indian money market and long-term rates remain static on Friday but any spike in the call rates will signal the tightening of the liquidity. Any uncertainty in the global markets and wavering RBI’s policy would see 10-year G-Sec yield moving up. In the case of upward movement in interest rate, duration bonds/ funds will see the negative impact. If there is tight liquidity in the market then the Default risk increases in Credit/ Accrual funds.
- Volatility is Unnerving: Instead of looking at the levels of indices and prices of stocks, it is always better to monitor Indian VIX to gauge the mood of the market. The VIX closes at 18.6275% on Friday though intraday it has touched 21.05% level. The correlation between spikes in VIX and market fall is well established.
- USD-INR, the thermometer: The appreciation of US Dollar vis-à-vis Indian Rupees will negatively impact both – our debt and equity market. The fallout from Brexit is rippling across foreign exchange markets, with safe haven currencies gaining. The Japanese yen is the best performer among G10 currencies, registering its biggest intraday gain versus Euro. The Japanese yen has also jumped past 100 per dollar for the first time since 2013. We should be wary of any sharp depreciation of Indian Rupees.
- Global Factors: Brexit was a global event which may trigger a Risk-off mode of Global investor and see FIIs pulling money out of emerging markets. One should look at
- COBE VIX volatility index – known as Wall Street’s fear gauge – surged 41 percent to 24.27 on Friday, above its long-term average of 20. Any further surge will lead to a deep cut in equity markets across the globe.
- US 10 year Treasury note: The 10-year Treasury yield was at 1.548%, down from 1.741% on Thursday. It is already at its lowest level, any further decline in the yield will be negative for emerging markets.
- The yen briefly touched 99 to the dollar — the highest since November 2013 — before retreating to 103.08 as of 5 p.m. on Friday in Tokyo. Flight of Capital towards safer currency like Japanese Yen indicates some very nervous moves, and continuing of such moves is a dangerous sign.
- The Chinese renminbi has weakened to its lowest level versus the USD since 2011. Worries of currency softness in the world’s second-largest economy invoke bad memories of the market turmoil in 2015 stemming from the August devaluation of the renminbi.
- British Pound goes into a tailspin: GBP/USDcloses at 1.3683 (-8.03%) on Friday after crashing more than 10% to 31-year lows. In August 1992, the Pound fell like a rock leading up to what’s remembered as Black Wednesday. The pound had lost 25% between August 1992 and Feb 1993. The USD shot up 15% in that time, but the S&P was up a healthy 7% and BSE Sensex was up 2.24%.
- Europe goes on Recession: If Europe goes into a recession because of Brexit trigger further European disintegration, this will lead to 20% fall in DAX but US indices may correct 5-10%. USD index may breach 100 levels and Oil will be below 40 USD/bbl. USD 10Yr T-note will correct more than 10% from current level of 1.55%. This will lead to Risk off from Global investor and our market may correct 10-20%.
We believe unless the Europe disintegrate further, Brexit in itself a small risk for our markets, but it may cause funds to flow to the US Dollar and US Treasuries over European debt. This is the reason we need to keep the close watch on INR level vis-à-vis US Dollar.