With Brexit, struggling world economy dealt yet another dagger
Date
6/26/2016 3:16:21 AM
(MENAFN- Khaleej Times) In a major shock to the markets, the UK has voted for a Brexit. The UK will now enter into formal negotiations to leave the EU, negotiations that are expected to take at least two years to complete. A global economy and world financial system that has been struggling to gain confidence and provide consistent performance has another serious tremor to deal with.
There is a risk of a major setback in the financial markets, if only because we have seen complete complacency going into the vote. The US equity market ended just shy of a 12-month high up 1.3 per cent and US government bonds had sold off. In the aftermath of the vote the equity markets are down five to seven per cent as an initial reaction. We expect the flight to safety to continue in the coming days. US treasuries, the yen and gold are the likely recipients of flows of money looking for a safe harbour from fears that global growth will slump back again. US 10-year government bond yields could fall to around the 1.40 per cent and gold to push on to $1,400. The global economy will have to absorb the fallout from the vote. The turmoil, particularly in the currency markets will undermine confidence. Companies will be anxious to see if there is an impact on the cost of financing. Whilst US government bond yields have fallen, government bond yields particularly for some European countries could rise. The world is left with a sense of uncertainty that tends to lead to slower economic growth. However, we must keep a sense of perspective; after all, the UK is just 2.3 per cent of global GDP. We do not expect too much in the way of immediate policy action from governments or central banks. Only at extremes might we start to see central banks deal in the currency markets. Sterling has reacted by falling precipitously to 1.350 with fears that we could see $1.20 before the fallout from the result is fully absorbed in the market. In the delusional trading just before polls closed, sterling traded as high as $1.50. As was expected the euro has followed sterling lower. In the last 24 hours the euro traded as high as 1.1428 to eventually plunge to $1.1162. Fair value for sterling is generally agreed to be around $1.55, however as we know currencies very rarely trade at fair value. If there is a material drop in confidence in global growth the oil price is likely to break the positive price channel we have seen develop since January. A further drag on the oil price will be the appreciation in the dollar. A potential target for the oil price would be for Brent to fall back to the low $40s. Gold should glisten in a world of currency volatility and uncertainty. Already we have seen the metal break above the $1,300 level. As investors digest the magnitude of what has happened we expect the gold price to continue to make progress possibly as the $1,400 level in the coming weeks. The writer is chief investment officer for wealth management at Emirates NBD. Views expressed are his own and do not reflect the newspaper''s policy.
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