Article / 29 June 2016 at 15:00 GMT

Brexit just a warm-up for global market convulsions

Head of FX Strategy / Saxo Bank
  • Britons voted for Brexit against polling results in run-up to voting day
  • Resulting sterling shock was bigger than in global financial crisis or 1992 ERM exit
  • Rejection of status quo calls into question QE, NIRP and ZIRP paradigm
  • Brexit proved a startling failure of status quo bias
  • Japan nearing inflection point; could that spark Japanese version of Brexit?
  • Trump candidacy a walking, talking rejection of status quo in the US
  • FX markets likely to remain unsettled; central banks' power is waning
  • Brexit will prove warm-up for global convulsions

Brexit bumper sticker
 The status quo was resoundingly rejected by the UK vote to leave the European Union.
Photo: iStock

By John J Hardy

The UK voted strongly in favour of leaving the EU, a shock to the market that was intensified by the market leaning hard on expectations of a "Remain" result in the days ahead of the vote. The resulting earthquake in sterling exchange rates easily outpaced the most intense phase of the global financial crisis or 1992’s Black Wednesday, when the pound was torn away from the European Exchange Rate Mechanism.

Most observations on the meaning of the Brexit vote are like the Indian parable of the blind men and the elephant. In that story, several blind men reach out and feel various parts of an elephant, each telling a wildly different story as to what they feel with their hands, and a heated argument ensues over what they are touching. So it is with Brexit. Some observers write it off as a xenophobic reaction to immigration policy and recent terror attacks. Others point to the burden of nanny-state European Union regulation and the cost of transfer payments to the EU.

But the EU itself is not even the elephant in the room. Rather the elephant in the room is government and central bank policymaking and the endless push to extend and pretend their way out of every crisis. These policies have fast-tracked us to our current underworld of quantitative easing and zero and now even negative interest rates — policies that were unthinkable 10 years ago.

The insidious march of QE and NIRP/ZIRP has been a boon to already powerful elites as asset markets have boomed on the zero cost of money for those with good credit. But together with the march of globalisation, labour’s share of the cake has shrunk, and the wild mispricing of money has left the business landscape crawling with unproductive companies and unproductive behaviour, such as highly profitable companies borrowing at almost zero cost to buy back their own stock and enrich shareholders.

Brexit was merely a remarkable opportunity for UK voters to voice popular disapproval of the “powers that be” — to say "No", not just to prime minister David Cameron or the EU, but to the whole shebang of the current paradigm. And one of the remarkable things about Brexit was the failure of the status quo bias, the behavioural tendency to prefer the known, no matter how miserable, to the unknown.

Ahead of the referendum, there was no clear vision for what a post-Brexit UK would look like, and it seems clear that the vote will likely lead to the UK losing Scotland and possibly more. Ahead of the vote, many pointed to the recent Scottish independence referendum and the 1995 Quebec referendum on independence from Canada as precedents, as in both cases the final vote saw a significant jump in favour of the status quo on voting day relative to previous polling. That so many in the UK were willing to leap into the unknown suggests shades of revolution, as the status quo was given the boot.

And from here, Brexit speaks very loudly for the outlook for currency and all financial markets on two fronts: political risks and the risk that central banks are losing control. 

The evidence of the latter has already been clear this year with the yen’s strengthening despite the enormity of the Bank of Japan’s quantitative easing programme. Now Japan is rapidly nearing an inflection point where its policymakers feel they must break ranks with recent summit agreements and devalue the yen again. Would that set in motion Japan’s version of Brexit? And what would that look like? A popular rejection of the BoJ’s and government’s attempt to devalue the currency and a sovereign debt crisis?

Elsewhere, the broad outlines of the forces that led to Brexit are glaringly evident in the US presidential election, where the Republican candidate Donald Trump is a walking and talking rejection of the status quo. Brexit should teach us above all to distrust the polls ahead of the November 8 general election. Motivated revolutionaries apparently turn out to vote more than the disengaged.

Looking to 2017, a possible French revolution lurks in the elections there. Currency markets are likely to remain unsettled as central bank signals aren’t what they used to be and as we all try to understand what comes next. Indeed, Brexit will prove to be the warm-up for a global revolution against the current market and policy paradigm.

French Revolution stamp (Delacroix)
 There's a whiff of revolution in the air. Photo: iStock

— Edited by John Acher

John J Hardy is head of FX strategy at Saxo Bank

29 June
Albee Albee
Thanks John for this piece. I do think things will get even more volatile as the younger generation (Millénials) have reach the tipping point of surpassing the boomers in terms of numbers. What will they vote? Breaking the statu quo even more? Or try to reach for power an make the changes necessary for a sustainable and durable world growth?
30 June
John J Hardy John J Hardy
Thanks for comment, Albee - yes, the next generation definitely holds the keys.
30 June
Clare MacCarthy Clare MacCarthy
More's the pity they didn't use those keys to unlock some progressive forces in the UK last week instead of waltzing around in the mud at Glastonbury and leaving the decision to their elders.
Sky Data's demographic breakdown of referendum turnout is:
18-24: 36%
25-34: 58%
35-44: 72%
45-54: 75%
55-64: 81%
65+: 83%
30 June
fxtime fxtime
Thx for the info seems (I am amazed) that it was mainly us all buggers that voted enmasse ! It would appear the vote leave campaign didn't have a plan as to how to implement their wishes...more over it seems they were really cheerleading for a chance to be prime minister. As the saying over here goes....careful for what you wish for. I was one of the few for remain....but watching Farage lambast MEPs earlier it struck me that he is trying to destroy any bridge building between Europe and the UK to ensure we really do pull away from Europe. Perhaps it would have been wiser for both sides to send him to Glastonbury mud fest :-)
30 June
fxtime fxtime
typo all = old !


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