The End of Globalisation

The UK has voted to leave the EU, by a narrow margin of 52-48, in what is the most significant pull back to-date from the post WWII consensus of closer integration and open trade.

While the actual path to exit is not yet clear, there are nonetheless profound implications for the UK. We expect a recession in the second half of the year and policy easing from the Bank of England. The domestic political turbulence may complicate the process of actually leaving the EU.

There are also significant implications for the EU. We expect the euro area economy to slow, with growing support for populist political parties of both left and right across Europe likely to raise the risk of further fragmentation of the Union.

For the rest of the world, the direct impact should be more muted, although there is a risk that financial turbulence has a real economy impact, with the market likely to begin to focus more acutely on the upcoming US election.

While this vote does not represent a systemic shock to the financial system on a par with Lehman or a Greek departure from the euro, it does represent a powerful turning point. The UK has taken a significant step back from globalization. That’s a trend gaining political support across the west. Such a significant secular shift has the potential to have substantial implications for growth, corporate profits and asset prices in the medium term.

Given the dramatic changes in asset prices overnight, the temptation for many may be to fade the moves. While we acknowledge the risk of a technical bounce back, we think the repricing in many markets has further to run:

FX Strategy: The dollar rally is likely to continue, with cable moving into the 120s, while dollar Yen could settle below 100. The only note of caution is the possibility of central bank intervention – possibly in a coordinated fashion.

Fixed income strategy: Benchmark yields are likely to rally further, with US 10-year yields threatening historical lows, while Germany and Japan will move further into uncharted negative territory. We also expect the UK rates market to eventually price for policy easing, with front-end curves inverting.

Equity Strategy: Our FTSE 100 year-end target falls to 6,200 from 6,600. We also take our S&P 500 year-end target to 2,000 from 2,150, and our Euro Stoxx 50 target to 2,950 from 3,350. We expect the FTSE 250 to underperform the FTSE 100 by 10% to 15%.

Credit Strategy: Our view is that the expected panic in credit markets will only last a day or two, and will provide an opportunity to buy at better levels.

EM Fixed Income: EM assets will be hit because they constitute risk assets and the leave vote will pull down commodity prices, which in turn help guide prices for many EM assets. However, we believe the negative risk market response to the referendum will be much smaller than the one that unfolded in the worst spell of the Eurozone crisis in 2011. We think EM spread-widening of 30% or less is likely.

Ric Deverell – Research Analyst – Credit Suisse
Neville Hill – Research Analyst – Credit Suisse