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Strategy Video: Has Brexit Finally Tipped Global Risk Aversion?

Strategy Video: Has Brexit Finally Tipped Global Risk Aversion?

2016-06-25 02:29:00
John Kicklighter, Chief Strategist

Talking Points:

  • The UK's decision in the EU Referendum holds carries systemic risk for Europe, global trade and global investors
  • Fractures in the world's largest collective economy - the EU - threatens economic stability
  • True risk arises from the protectionism, monetary policy distortion and excessive risk exposure already in place

See how retail traders are positioning in the majors using SSI readings on DailyFX's sentiment page.

While the United Kingdom's decision to leave the European Union holds profound fundamental implication for the British Pound and its capital markets; this event likely holds more systemic consequence. It is important to remember the environment in which this event has occurred. We have seen a global economy that has significantly decelerated. Financial connections and trade that have been plagued with overt threats (and now actions) of protectionism. And, markets that have built a precarious dependency on monetary policy-derived stability that made record low returns somehow tolerable.

That delicate balance has been shaken this past week. While the chain reactions will ultimately be complex, they are likely too numerous not to catalyze. Through the economic channels, the threat of recession in the UK pales in comparison to the crisis of confidence that arises for the stability of the European Union. Even more profound are the implications this step back from globalization carries for a global economy that has benefit from greater integration. Further efforts along these lines are likely to follow, and the environmental change will exacerbate any cyclical or one-off issues that arise moving forward.

The more virulent risk arises from the financial balance. A long period of stability has been purchased at high cost in monetary policy that has eroded firepower to fight future crisis while building unrealistic expectations for returns. Meanwhile, market-based yields have eroded to record lows forcing a dependency on capital gains and artificially-low volatility. Moving forward, the transmission of risk and deleveraging will likely be more fluid. Further catalysts like China, economic slowdown, further protectionist moves and simply strong bouts of capital flight can escalate a global transition of sentiment and exposure. We discuss the big move towards risk aversion that we've made this past week in the Strategy Video.

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