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Its been nearly 2 months since the historic Brexit vote and 6 weeks since the Bank of England issued a stronger response to the Brexit than many economists forecasted. The same policy makers are now having to assess whether their outlook requires a change in strategy.
Economic data released following the vote to leave the European Union has been better than expected. Indicators based on sentiment along with statistics representing services and manufacturing have bounced back quite strongly from July which saw these figures dropping substantially. The initial response was that these numbers would continue to drop spreading fear and panic but the numbers are proving to be anything but frightful.
The Majority of traders were certain the Bank of England will keep rates unchanged at 0.25% on Thursday the 15th of September and as such they did. They had cut the rates on August 4th from 0.5% to 0.25%. Expectations for a further cut have also been trimmed.
However the GBP has experienced multiple bouts of volatility following the vote, which has since subsided sufficiently, however regardless what happens with regards to the interest rate decision and the vast amount of economic indicators being released constantly, volatility can return at any time.


Article 50

  • EU regulations say that any country that wants to withdraw from the EU may do so.
  • The process for how a country can withdraw is set out in Article 50 of the Lisbon Treaty, one of the treaties that forms the basis of EU law.
  • The key point in Article 50 is that until a country notifies the EU of its intention to withdraw, nothing happens. Once it notifies the EU of its intention, then the withdrawal process starts with a two-year deadline.

The British just voted in a referendum to leave the European Union (EU). But just voting on it doesn’t make it so. There are steps that a member country has to take in order to withdraw. These steps are described in Article 50 of the Lisbon Treaty1, one of the treaties that forms the basis of EU law.

Article 50 (shown below) says that “(a) Member State which decides to withdraw shall notify the European Council of its intention.” After the EC is informed, official negotiations can begin. Once negotiations begin, the two sides have two years to finish them. If negotiations aren’t finished after two years, the country is out regardless.

The key point is this: the member state has to notify EC of its intention to withdraw from the EU. Until the country has submitted this formal notification, nothing changes. Moreover, the EU can’t do anything to speed up the notification. It can only wait for the letter.

Now that the UK has voted to leave the EU, attention is turning to exactly when the UK government will notify the EU authorities under Article 50 and trigger the beginning of the two-year negotiation period. Originally, PM Cameron had said this would be happen immediately after the referendum, but he also said that he would remain as PM. Both turned out to be wrong. Apparently, nobody is in much of a rush to notify the EU.

Indeed, there are several reasons to think that this won’t happen any time soon. Cameron’s resignation pushes the task of sending the notice onto the next PM, who won’t take office until probably September at the earliest. This was quite a clever move, as it forces the “Leave” side to take full responsibility for their actions. It’s notable that many of the key figures behind the “Leave” campaign are showing no urgency to get on with it. Boris Johnson, one of the leaders of the “Leave” side and expected to be the next PM, has said that change “will not come in any great rush.” Leaders of the “Leave” campaign are admitting that many of their promises were only “possibilities,” as one put it, and now that they have to fulfill them, they are not so eager.

Secondly, very few people in power in the UK wanted to leave the EU. For example, it’s estimated that two-thirds of the Members of Parliament wanted to stay, and according to the UK system of government, Parliament – not the people – are in charge. So Parliament may at least delay sending the notification.

A further complication is the need to get approval by the governments of Scotland and Northern Ireland, both of which voted to stay in the EU. Although they have no legal veto, they could (and probably will) try to block the move. That issue may have to be cleared up before the notification can be sent.

In short, although the UK voters did endorse leaving the EU in the recently held referendum, this is not the same as actually leaving the EU. Expect to be reading about this issue for some time.

Article 50

A qualified majority shall be defined in accordance with Article 238(3)(b) of the Treaty on the Functioning of the European Union.

  1. Any Member State may decide to withdraw from the Union in accordance with its own constitutional requirements.
  2. A Member State which decides to withdraw shall notify the European Council of its intention. In the light of the guidelines provided by the European Council, the Union shall negotiate and conclude an agreement with that State, setting out the arrangements for its withdrawal, taking account of the framework for its future relationship with the Union. That agreement shall be negotiated in accordance with Article 218(3) of the Treaty on the Functioning of the European Union. It shall be concluded on behalf of the Union by the Council, acting by a qualified majority, after obtaining the consent of the European Parliament.
  3. The Treaties shall cease to apply to the State in question from the date of entry into force of the withdrawal agreement or, failing that, two years after the notification referred to in paragraph 2, unless the European Council, in agreement with the Member State concerned, unanimously decides to extend this period.
  4. For the purposes of paragraphs 2 and 3, the member of the European Council or of the Council representing the withdrawing Member State shall not participate in the discussions of the European Council or Council or in decisions concerning it.
  5. If a State which has withdrawn from the Union asks to rejoin, its request shall be subject to the procedure referred to in Article 49.

Article published on the 30th June 2016.

1 The Treaty of Lisbon(initially known as the Reform Treaty) is an international agreement that amends the two treaties which form the constitutional basis of the European Union (EU). The Treaty of Lisbon was signed by the EU member states on 13 Dec 2007, and entered into force on 1 Dec 2009.

The Brexit vote was certainly shocking! Although all the polls said it was going to be close, I had expected that when push comes to shove, people would vote for no change, as they usually do. I was wrong and so was most of the market, apparently. The pound suffered its biggest one-day drop ever and many other currencies, such as JPY and CHF, saw enormous moves as well.

I’ve been in the markets almost 40 years and I’d say that this was the most significant scheduled event I’ve ever experienced. There were a lot of important surprises, like the fall of the Berlin Wall or the collapse of Lehman Bros., but I’ve never, ever seen a scheduled, orderly event that changed history like this before.

Everyone’s wondering now, what’s next? The problem is, this has never happened before so we don’t really have any precedent to go by. We only have questions, not answers. And as you know, markets dislike uncertainty.

Some of these questions are:

  1. Who will replace PM David Cameron? What will the new person’s policies be? Will the Chancellor, George Osborne, be able to continue in his position? What will be the impact on fiscal policy? No idea.
  2. Will the UK Parliament go along with the referendum? The referendum actually isn’t legally binding, and the majority of MPs don’t want to leave the EU. However I think it’s impossible for them to ignore this vote.
  3. In order to withdraw from the EU, Article 50 of the Treaty of the EU says that Britain has to notify the EU of its intention to withdraw. But it doesn’t say how quickly Britain has to notify it. When will they notify the EU? Nobody knows. Probably PM Cameron will leave that to the next PM.
  4. Once they officially notify the EU of their intention to withdraw, the two sides have two years to negotiate the terms of the withdrawal. At the end of two years, it’s out. What terms will they be able to negotiate? Nobody knows. It’s certain though that the other European countries won’t be happy to see Britain go and won’t want to make it easy on them.
  5. How will they negotiate all the other necessary treaties? Britain will also have to negotiate trade treaties with every other country in the world. However, for the last 40 years, the EU has done all of Britain’s trade negotiating for them. As a result there aren’t more than 20 people left in the government with experience in this field! It will be a disaster.
  6. Will Scotland leave? The Scottish National Party has said that if Britain votes to leave the EU, they will try to call another vote on Scottish independence. So while Britain is trying to leave the EU, Scotland will be trying to leave Britain.
  7. What will Northern Ireland do? Northern Ireland voted Remain as well. The province will now have an international border between it and the South. Will they decide to Remain?
  8. What will be the impact on the British economy? For the time being, Britain remains a member of the EU, with all the rights & privileges. However, consumption, investment, and particularly foreign direct investment are likely to fall during the uncertain period while they negotiate the new trade agreements. That suggest to me a weaker economy and a weaker pound. On the other hand, the 10% fall in Britain’s trade-weighted index overnight is likely to boost exports, at least while Britain retains its EU membership and trade benefits.
  9. How will the Bank of England respond? The fall in the pound makes a rise in inflation more likely, but the shock to the economy means slower growth. Which problem will they prioritize? I don’t think even they know yet. (I expect they’ll prioritize growth by keeping rates low, which is likely to weigh on the currency.)
  10. What will happen with European politics? The Brexit decision is devastating for Britain, but it’s potentially even worse for the EU! If Britain can leave, other countries can leave, too. The vote will give a big boost to Euro-sceptic political parties throughout the EU. Integration of policy is bound to come to a screeching halt as citizens demand more sovereignty and less Europe. Note that continental European stock markets fell much more than the UK stock market today.
  11. What will happen with the Eurozone? Unfortunately, the Eurozone is not an optimal zone for a single currency. It’s hard to have a single monetary policy without having a single fiscal policy. The Eurozone needs more integration, not less. The rise of Eurosceptic parties is going to make it more difficult if not impossible to deal with issues such as the Greek debt, bank insolvencies. That’s likely to weigh on the euro.
  12. How will this affect Fed policy? One of the FOMC’s criteria for hiking rates has been “financial stability.” Clearly this event
  13. Finally, if Britain can choose to disregard the united view of the political and economic Establishment, does this mean that Donald Trump has a chance to win in the US? I don’t even want to think about that possibility.

There are 3 possible scenarios now for the EU:

  1. The shock to the European system causes European leaders to rethink the European project and begin major reforms that reinvigorate the whole endevour. Not likely.
  2. On the other hand, Eurosceptic parties throughout the EU become emboldened. In order not to upset them, politicians stop all attempts to move towards further integration. Other countries contemplate leaving as well. The EU could get stuck in paralysis indefinitely. Possible.
  3. The usual solution for the EU: muddle through. Integration would be put on hold for the next 15 months while Spain, France, Netherlands and Germany hold elections, but then they resume modest efforts along the line that they’ve been pursuing. Most likely.

All told, there are a lot of political problems and not many easy solutions. That suggests to me that once again, those in power will rely on monetary policy. I see British and Eurozone monetary policy remaining looser for longer than it would have otherwise been. That, together with the unparalleled uncertainty, means a weaker pound and weaker euro. The dollar, the yen, the Swiss franc and gold are the likely beneficiaries in the short term. In the longer term, I think EM currencies with higher interest rates and decent fundamentals, such as MXN, could benefit from the lower-for-longer stance of the major central banks.

The Brexit vote – the vote on whether the UK should leave the EU – has arrived.

I can’t overemphasize how important this vote is for the markets. IMF head Christine Lagarde last month warned that if Britain voted to leave, the impact would range from “pretty bad to very, very bad.” Finnish finance minister, Alexander Stubb, said it could be "the Lehman Brothers moment of Europe," if you remember how bad that was.

One day prior to the vote, the market expects the "Remain" side to win. The bookies give “Remain” about a 75% likelihood. GBP/USD is almost back to the high for the year, set on 1 January, when “Remain” had a solid lead in the polls – indicating that most of the Brexit risk is now out of the market.

However, the polls aren’t so certain. They show the two sides pretty evenly matched. Of course, the polls aren’t perfect – in fact they have a pretty poor track record. In any event, there’s still a large proportion of people who are uncertain, a large enough proportion to sway it either way.

Nonetheless, the market seems to be discounting "Remain." What that means is if the vote does go that way, the relief rally is likely to be modest. I’d expect to see stocks rally, gold fall, and both sterling and the euro gain, although not that dramatically. Note that UK stocks have outperformed the continental European stock markets so far this year, so we can’t expect a huge surge of money into the UK immediately. Over time there should be a recovery in direct investment in Britain, which has fallen off due to uncertainty ahead of the referendum. That should allow the pound to recover, but gradual at best.

On the other hand, if they vote to leave, there is likely to be chaos. As I mentioned, that’s not what the market is prepared for, so it would come as a surprise. In the first case, the pound would plunge. The euro would also come under pressure, I expect. Funds would flow out of these currencies and into the dollar, plus the two safe-haven currencies, JPY and CHF (although we can expect the Swiss National Bank and the Bank of Japan to intervene to keep them from appreciating too much). Stock markets globally would fall on a general risk-aversion trade, I imagine, while gold would probably get a boost.

The initial problem is the uncertainty that Britain leaving the EU would cause. With no trade agreements with its major trading partner, the UK economy would suffer a major shock. Nobody knows exactly how long it would take to establish a new framework and nobody knows exactly how it would work. And markets hate uncertainty.

The direct economic impact is really the least of the problems. Central bank intervention can help the markets to survive the initial shock. UK and EU trade may suffer, but it will probably just mean slower growth, not depression. The big problem is the implication for the whole European project, the "ever closer union" that the EU is pledged to pursue. It really throws the whole EU into question. That’s why I think the euro would get hit hard, too. In fact, the reverberations might be heard only three days later, on Sunday, when Spain holds a general election.

This vote has the potential to be the biggest market event of the year. If you’ve got a position in the markets, you’d better think how it’s going to be affected by the vote.


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Risk Warning: Trading on margin products involves a high level of risk , which may result in the loss of all invested capital.
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