by To say that the Brexit vote on June 23 took financial markets by surprise would be an understatement. The pound, British stocks, and Gilt yields had all risen sharply in the week leading up to the vote, only to crash once the results started coming in. Broadly speaking, strategists on Credit Suisse’s Global Markets and Investment Solutions and Products (IS&P) teams expect markets to remain volatile in the coming days and for investors to prefer safe assets to risky ones. Below, we highlight views from across the bank on how Britain’s referendum vote to leave the European Union is likely to affect both the British and European economies, as well as a broad spectrum of financial assets. Economic Impact Both Credit Suisse’s Global Markets and IS&P teams believe that the Brexit vote will create considerable uncertainty for British businesses that will ultimately lead to a decline in GDP – and both teams also believe that the Bank of England will step in with rate cuts. The Global Markets team expects the Bank of England to cut rates from 0.5 percent to 0.05 percent and implement another round of quantitative easing to the tune of £75 billion no later than August 2016.
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To say that the Brexit vote on June 23 took financial markets by surprise would be an understatement. The pound, British stocks, and Gilt yields had all risen sharply in the week leading up to the vote, only to crash once the results started coming in. Broadly speaking, strategists on Credit Suisse’s Global Markets and Investment Solutions and Products (IS&P) teams expect markets to remain volatile in the coming days and for investors to prefer safe assets to risky ones. Below, we highlight views from across the bank on how Britain’s referendum vote to leave the European Union is likely to affect both the British and European economies, as well as a broad spectrum of financial assets.
Economic Impact
Both Credit Suisse’s Global Markets and IS&P teams believe that the Brexit vote will create considerable uncertainty for British businesses that will ultimately lead to a decline in GDP – and both teams also believe that the Bank of England will step in with rate cuts. The Global Markets team expects the Bank of England to cut rates from 0.5 percent to 0.05 percent and implement another round of quantitative easing to the tune of £75 billion no later than August 2016. Michael O’Sullivan, Credit Suisse’s Chief Investment Officer for International Wealth Management, points out that central banks around the world are on alert to step in to ensure their own banking systems have adequate liquidity.
In addition to weak corporate spending, Global Markets economists expect rising inflation and the depreciation of the British pound to squeeze household spending. As a result, they forecast that GDP will fall 1 percent between the third quarter of 2016 and the first quarter of 2017, and have reduced their growth forecasts for 2016 from 1.8 percent to 1 percent and the 2017 growth forecast from 2.3 percent to -1 percent. Credit Suisse’s IS&P analysts also foresee a significant growth slowdown, and both teams think it likely that the deteriorating value of the pound will cause headline inflation to spike.
The Global Markets team also expects a setback to the recent pickup in corporate spending more broadly in Europe, as well as tightening financial conditions. The team’s economists have lowered their European GDP growth expectations from 1.7 percent to 1.5 percent in 2016 and from 2 percent to 1 percent in 2017. Credit Suisse’s IS&P team believes that the Eurozone will not follow the U.K. into recession unless the Brexit vote results in severe financial contagion to peripheral economies such as Italy, but the analysts on the team view this as a tail risk. The IS&P team believes the European Central Bank will extend its quantitative easing program, while the Global Markets team believes that further easing through the existing TLTRO program, which offers low-interest financing to commercial banks, is possible.
Fixed Income
Yields on 10-year Gilts, Bunds, and Treasuries all plummeted after the Brexit vote as investors sought refuge in safe assets, and the bank expects continued volatility over the coming weeks. Credit Suisse’s Investment Committee notes that renewed questions about European stability could widen spreads on government bonds in the periphery, while Credit Suisse’s Global Markets team believes benchmark U.S. Treasury yields may plumb new depths. The outlook for Gilts is somewhat more complicated. The Global Markets team expects interest rates on British government bonds to drop as investors start to anticipate easing from the Bank of England, but they also note that a disorderly depreciation of the pound could cause speculation that the central bank would actually tighten policy, driving rates higher.
But the ripple effects of a flight to safety will be felt well beyond Britain or the EU. The bank’s IS&P team notes that financial credits – particularly subordinated bank debt – are the most vulnerable corporate bond investments. Investment-grade credit should hold up better, particularly in the U.S.
Currency
Strategists on the Global Markets and IS&P teams expect that FX investors will continue to migrate into traditional safe-haven currencies such as the Japanese yen, Swiss franc, and U.S. dollar, a transition that began in earnest once the referendum results started to swing toward the Brexit camp. Swiss authorities acknowledged June 24 that they had intervened in the foreign-exchange market to weaken the franc after the Brexit vote sent the currency soaring against both the euro and the pound. With concerns about European cohesion on the rise, the euro is likely to face further downward pressure, as will many emerging-market currencies.
Credit Suisse believes that the pound may ultimately fall below $1.30 to the pound, nearly a 15 percent markdown from the $1.48 close the day of the referendum. Noting that the United Kingdom has the largest current account deficit in the G10, the Global Markets team cautions that the U.K. is only sitting on foreign-exchange reserves worth 6 percent of GDP to defend the currency should it come under attack. That being the case, coordinated intervention would likely be more effective than England going it alone. For Japan and Switzerland, there’s a potential incentive to coordinate, as selling yen or francs in order to buy pounds would help weaken their own currencies.
Equities
British financial and real estate businesses (and by extension, equities) will bear the brunt of the Brexit vote. If the financial services industry loses the “passporting” rights that allow it to sell its services across Europe’s single market, investment banks could move personnel and business overseas. Equity strategists on the Global Markets team have posited that German REITs could see a boost from London bankers transferring to the continent.
Credit Suisse’s Investment Committee has downgraded European stocks to neutral and British stocks to underperform, while upgrading U.S. stocks to neutral. Credit Suisse’s Global Markets strategists moved their year-end targets from 6,600 to 6,200 on the FTSE 100, 2,150 to 2,000 on the S&P 500, and 3,350 to 2,950 on the Eurostoxx 50.