Ameriprise Financial : Investors Seek Safety as Uncertainty Looms After Brexit

The implications of Britain's vote to leave the EU remain uncertain. In the short-run, it seems likely that economic activity in the United Kingdom, EU and global economy is likely to slow as economic decision making is put on hold. Yearly growth forecasts for each of these regions were being lowered over the weekend by roughly one half percent on average.

In one immediate example, real estate transactions in London were reportedly being cancelled abruptly on Friday following the vote. UK realtors are expecting home prices across the country to fall by five percent and by ten percent in central London. The political implications of the vote also remain unclear, especially after Scotland and Northern Ireland both voted to stay in the EU. And while Spanish voters on Sunday expressed more moderate sentiment than their UK counterparts, the populist voices on the continent have been emboldened by the UK decision, casting uncertainty onto the future of the EU itself.

Uncertainty is likely to prevail for some time. For a country to begin the up to two-year process to leave the EU, its government must explicitly express its desire to do so, invoking Article 50 of the Lisbon treaty. Lame duck Prime Minister Cameron has said that his successor should be the one to do so. The process of identifying that successor could take months. Meanwhile, EU officials are urging the UK to begin the process immediately. In addition to negotiating the terms of exit is the dual track to negotiate the terms of the UK's future relationship with the EU, a process that could take an estimated five years or more.

Investors Turn to Safe Haven Assets in Response to Uncertainty

The cascading selling pressure and the corresponding flight to safe haven assets seen on Friday was an immediate response to this uncertainty. As markets are opening on Monday that selling pressure is continuing, albeit at a more subdued pace. The British pound is lower by another 3.3 percent versus the dollar, on top of the 8.1 percent decline it suffered on Friday. Stocks in Europe are also lower in early trading. The EuroStoxx 50 index is down 1.9 percent three hours into the trading day, led by a further 4.0 percent decline in the banks. The FTSE 100 index is lower by a similar amount, led by a 6.0 percent decline in the banks. In less than a day and a half of trading Barclays, Lloyds and RBS are each lower by almost 30 percent.

In contrast, there was relative calm in Japan overnight as the Nikkei rose 2.4 percent, offsetting some of its 8.0 percent decline on Friday, despite further gains in the yen to its strongest level versus the dollar in two years. Sovereign bond yields have also accelerated their decline. Ten-year gilts yields are lower this morning by another 14 basis points to 0.95 percent. Before Thursday's vote the yield was 1.37 percent. German bund yields are lower by 5 basis points to yield -0.11 percent. And ten-year Treasury yields are lower by 9 basis points to 1.47 percent. The yield on the Treasury two-year note now sits at 0.57 percent, down from 0.78 percent before Thursday's vote.

What Might we Expect to see in the Coming Weeks?

As for the Fed, the futures market is now assigning just a 2 percent probability of an interest rate hike in November and 15 percent in December. The DXY dollar index is also adding to Friday's strength and has now climbed over 3 percent in less than two days of trading. After climbing 5 percent on Thursday, gold is also rising once again, but only modestly.

While the extent of the selling pressure in risk assets so far has been significant, it may be too early to go bargain hunting. The path forward for the UK and EU is too uncertain to anticipate when the selling pressure will abate. Markets are likely to overshoot on the downside, and opportunities could emerge as they do, but we may not be there yet. A defensive posture likely remains the best course of action until we have more clarity on the way forward, and that will take some time.

Important Disclosures:
The FTSE 100 is a market-weighted index of the 100 leading companies traded in Great Britain on the London Stock Exchange.
The Nikkei index is a price-weighted average of 225 stocks of the first section of the Tokyo Stock Exchange.
The U.S. Dollar Index (DXY) measures the dollar's value against a trade-weighted basket of six major currencies.
The EURO STOXX 50 is a market capitalization-weighted stock index of 50 large, blue-chip European companies operating within eurozone nations. The universe for selection is found within the 18 Dow Jones EURO STOXX Supersector indexes, from which members are ranked by size and placed on a selection list.
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