Britain has a ballot, but does it have a plan?
- Fitch, S&P, Moody's downgrade the UK
- Risky assets face troubled waters
- British government 'needs a plan'
By Neil Staines
“To leave Europe once may be regarded as a misfortune. To leave twice in a week looks like carelessness” — @Tim_Burgess
In the 1992/93 Scottish football league season, Partick Thistle FC manager John Lambie was informed that, after a collision with an opponent, one of his players had a concussion and didn’t know who he was, Lambie replied “That’s great, tell him he’s Pele and get him back on”.
Last night, with no exceptions, the England football team lacked that kind of belief. They also lacked organisation and perhaps most importantly, a plan. A comparison between last night’s 90 minutes and the UK’s last 90 hours offers many analogies. One thing that remains elusive, and (increasingly) much-needed, is a plan.
In a precursor to the football, S&P reduced its credit rating on the UK by two notches to AA, citing the risk of a less predictable, less stable and less effective policy framework. Fitch cut its rating by one notch to an equivalent level. Both maintain a negative outlook.
Fitch cited the likelihood of “an abrupt slowdown” in economic growth and S&P commented that the downgrade reflects the “risks of a marked deterioration in external financing conditions”. It is perhaps ironic that the institutions much vilified for maintaining the AAA ratings on subprime mortgage bonds for far too long after the underlying loans began to fail at alarming rates, have now taken action before they (or anyone else for that matter) know what the plan is.
The probability of the UK invoking article 50 of the Lisbon Treaty (and thus beginning the formal process of exiting the EU) is not one.
“Everyone has a plan, until they get punched in the face” —Mike Tyson
Since the surprise result of the UK’s EU referendum last week, financial markets have remained unsettled. The central pillar of uncertainty for financial markets at the current juncture, however, is likely political, not economic.
In the long term, it is a political plan that will determine the playing surface and thus market pricing. In the short term, however, the shock and uncertainty in the system is, in our view, sufficient to undermine equities and risk assets. Those same equities and risk assets that we have been arguing for the past several months are overvalued.
The UK government (whatever that looks like) must continue to make it clear to both the UK and the rest of Europe that it will remain a committed and cooperative European, simply one that does not wish to be part of a political union that is increasingly inefficient, and misaligned with the increasingly competitive global macroeconomy. The UK government needs a plan.
“Every exit is an entry to somewhere else” — Tom Stoppard
Global central banks have stated that they stand ready to provide sufficient liquidity to maintain the integrity and stability of financial markets. In our view, this (and the vast improvement in the capital base of the global banking system; UK bank capital is 10 times its pre-2008 levels) likely means a vastly reduced prospect of a systemic crisis (the sharp normalisation in the cross-currency basis highlights the temporary nature of the "stress" in funding markets following Friday’s surprise).
Yet this is likely to do little, in anything but the very short term, to arrest the re-pricing of equities and risk assets.
In FX, the overnight stabilisation in CNY was commensurate with the calming of the broader selloff in risk assets. However, the theme of risk-off likely continues to play out, and as the political uncertainty continues in the UK, GBP will likely remain under pressure, although relative to the EUR, it is likely that we are not too far from the pinnacle of one-sidedness.
If extricating ourselves from an inflexible EU is bad for the UK, it likely follows that it is also bad for the EU, and thus the EUR. The opposite is likely true of the USD.
Furthermore, in a world where risk appetite dominates, traditional safe-haven currencies such as the JPY and CHF (though perhaps less so this side of the "cap" debacle) will likely outperform.
Those sensitive to global growth and Chinese prosperity, such as AUD, NZD and even ZAR, would be our preferred underperformers against the current backdrop.
USDZAR ready to rally?
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— Edited by Michael McKenna
Neil Staines is head of trading at The ECU Group