Friday, June 24, 2016

Europe's Minsky Moment?

Herbert Lash and Marc Jones of Reuters report, World stocks tumble as Britain votes for EU exit:
Global capital markets reeled on Friday after Britain voted to leave the European Union, with $2 trillion in value wiped from equity bourses worldwide, while money poured into safe-haven gold and government bonds. Sterling suffered a record plunge.

The blow to investor confidence and the uncertainty the vote has sparked could keep the Federal Reserve from raising interest rates as planned this year, and even spark a new round of emergency policy easing from major central banks.

The traditional safe-harbor assets of top-rated government debt, the Japanese yen and gold all jumped. Spot gold rose more than 5 percent and the yield on the benchmark 10-year U.S. Treasury note fell to lows last seen in 2012 at 1.5445 percent.

Stocks tumbled in Europe. London's FTSE dropped 2.4 percent while Frankfurt and Paris each fell 6 percent to 8 percent. Italian and Spanish markets, and European bank stocks overall, were headed for their sharpest one-day drops ever.

Worries that other EU states could hold their own referendums were compounded by the fact that markets had rallied on Thursday, seemingly convinced the UK would vote to stay in.

Britain's big banks took a $100 billion battering, with Lloyds, Barclays and RBS plunging as much as 30 percent.

Stocks on Wall Street opened more than 2 percent lower but cut losses after about an hour of trading. The Dow Jones industrial average fell 340.24 points, or 1.89 percent, at 17,670.83, the S&P 500 lost 42.11 points, or 1.99 percent, at 2,071.21 and the Nasdaq Composite dropped 116.74 points, or 2.38 percent, at 4,793.31.

MSCI's all-country world stock index fell 3.5 percent.

Having campaigned to keep the country in the EU, British Prime Minister David Cameron announced he would step down.

Results showed a 51.9/48.1 percent split for leaving, setting the UK on an uncertain path and dealing the largest setback to European efforts to forge greater unity since World War Two.

More angst came as Scotland's first minister said the option of another vote for her country to split from the UK - rejected by Scottish voters two years ago - was now firmly on the table.

The British pound dived by 18 U.S. cents at one point, easily the biggest fall in living memory, to its lowest since 1985. The euro, in turn, slid 3 percent to $1.1050 as investors feared for its very future.

Sterling was last down 7.8 percent at $1.3719, having carved out a range of $1.3228 to $1.5022. The fall was even larger than during the global financial crisis and the currency was moving two or three cents in the blink of an eye.

"It's an extraordinary move for financial markets and also for democracy," said co-head of portfolio investments of London-based currency specialist Millennium Global Richard Benson.

"The market is pricing interest rate cuts from the big central banks and we assume there will be a global liquidity add from them," he added.

That message was being broadcast loud and clear. The Bank of England, European Central Bank and the People's Bank of China all said they were ready to provide liquidity if needed to ensure global market stability.


The shockwaves affected all asset classes and regions.

The safe-haven yen jumped 3.6 percent to 102.29 per dollar, having been as low as 106.81. The dollar's peak decline of 4 percent was the largest since 1998.

That prompted warnings from Japanese officials that excessive forex moves were undesirable. Traders said they were wary of being caught with exposed positions if the global central banks chose to step in to calm the volatility.

Emerging market currencies across Asia and eastern Europe and South Africa's rand all buckled on fears that investors could pull out. Poland saw its zloty slump 4 percent.

Europe's natural safety play, the 10-year German government bond, surged to send its yields tumbling back into negative territory and a new record low.

MSCI's broadest index of Asia-Pacific shares outside Japan slid almost 5 percent, Tokyo's Nikkei saw its worst fall since 2011, down 7.9 percent.

Financial markets have been gripped for months by worries about what a British exit from the EU would mean for Europe's stability.

"Obviously, there will be a large spill-over effects across all global economies ... Not only will the UK go into recession, Europe will follow suit," predicted Matt Sherwood, head of investment strategy at fund manager Perpetual in Sydney.


Investors stampeded into low-risk sovereign bonds, with U.S. 10-year notes gained two full points in price to yield 1.521 percent. Earlier, the yield dipped to 1.406 percent, only slightly higher than a record low 1.38 percent reached in July 2012.

“Right now it’s 'every man for himself' safety buying," said Tom Tucci, head of Treasuries trading at CIBC in New York.

The rally even extended to UK bonds, despite a warning from ratings agency Standard & Poor's that it was likely to downgrade Britain's triple-A credit rating if it left the EU. Yields on benchmark 10-year gilts fell 27 basis points to 1.0092 pct.

Across the Atlantic, investors were pricing in less chance of another hike in U.S. interest rates given the Federal Reserve had cited a British exit from the EU as one reason to be cautious on tightening.

"A July (hike) is definitely off the table," said Mike Baele, managing director with the private client reserve group at U.S. Bank in Portland, Oregon.
Fed funds futures were even toying with the chance that the next move could be a cut in U.S. rates.

Oil prices slumped by more than 4 percent amid fears of a broader economic slowdown that could reduce demand. U.S. crude shed $2.12 to $47.99 a barrel while Brent fell as much as 6 percent to $47.83 before clawing back to $48.60.

Industrial metal copper sank 3 percent but gold galloped more than 6 percent higher thanks to its perceived safe haven status.
A couple of days ago I wrote a comment to Brexit or not to Brexit where I stated my strong doubts that the Brits would opt out of the EU.

I was wrong, foolishly believing most people in the UK would vote rationally with their wallets. But in the end, populism won the day, which makes you wonder whether referendums should require 2/3 majority to set in motion any major decision impacting millions of people (Winston Churchill was right: "Democracy is the worst form of government, except for all the others").

However, in my comment on Brexit, I stated the following:
[...] let's say Brexit happens, then what? Well, investors will seek refuge in good old US bonds, they're going to sell the euro and pound and buy the yen. Markets will be in a tizzy and volatility will shoot up. Conversely, if Brexit doesn't happen, the euro and pound will rally, the yen and US bonds will sell off and global stocks and corporate bonds will take off.

Of course, if you ask Mr. Yen, the yen will strengthen past 100 per dollar this year, whichever way the UK votes in Thursday’s referendum. I hope he's wrong as the surging yen could trigger a crisis, especially another Asian financial crisis.

One thing is for sure,  David Cameron, the British prime minister, has no one to blame but himself for this vote. What else? The favorable opinion of the EU is plunging everywhere, especially in France.

In fact, regardless of the outcome in this week's referendum, Brussels has a huge problem, one that I see getting worse as the euro zone struggles to escape deflation.
The problem now isn't Brexit, it's the fallout from Brexit. The BBC reports that Brexit sparks calls for other EU votes:
The UK's vote to leave the EU has sparked demands from far-right parties for referendums in other member states.

France's National Front leader Marine Le Pen said the French must now also have the right to choose.

Dutch anti-immigration politician Geert Wilders said the Netherlands deserved a "Nexit" vote while Italy's Northern League said: "Now it's our turn".

The UK voted by 52% to 48% to leave the EU after 43 years. David Cameron has announced he will step down as PM.

Global stock markets fell heavily on the news and the value of the pound has also fallen dramatically.

The European parliament has called a special session for next Tuesday.

Analysts say EU politicians will fear a domino effect from Brexit that could threaten the whole organisation.

Ms Le Pen hailed the UK vote, placing a union jack flag on her Twitter page and tweeting: "Victory for freedom. As I've been saying for years, we must now have the same referendum in France and other EU countries."

She is the front-runner among candidates for the presidential election in 2017 but opinion polls suggest she would lose a run-off vote.

Alarm bells - BBC Europe editor, Katya Adler

The EU worries Brexit could reverse 70 years of European integration.

In all my years watching European politics, I have never seen such a widespread sense of Euroscepticism.

Plenty of Europeans looked on with envy as Britain cast its In/Out vote. Many of the complaints about the EU raised by the Leave campaign resonated with voters across the continent.

Across Europe leading Eurosceptic politicians queued up this morning to crow about the UK referendum result.

But the mood in Brussels is deeply gloomy. The Brexit vote sends screaming alarm bells, warning that the EU in its current form isn't working.


Last Friday, Ms Le Pen had told a gathering of far-right parties in Vienna: "France has possibly 1,000 more reasons to want to leave the EU than the English."

She said the EU was responsible for high unemployment and failing to keep out "smugglers, terrorists and economic migrants".

Mr Wilders, leader of the Party for Freedom in the Netherlands, said in a statement: "We want to be in charge of our own country, our own money, our own borders, and our own immigration policy.

"As quickly as possible the Dutch need to get the opportunity to have their say about Dutch membership of the European Union."

The Netherlands faces a general election in March and some opinion polls suggest Mr Wilders is leading. A recent Dutch survey suggested 54% of the people wanted a referendum.

Mateo Salvini, the leader of Italy's anti-immigration Northern League, tweeted: "Hurrah for the courage of free citizens! Heart, brain and pride defeated lies, threats and blackmail.

"THANK YOU UK, now it's our turn."

The anti-immigration Sweden Democrats wrote on Twitter that "now we wait for swexit!"

Kristian Thulesen Dahl, leader of the populist Danish People's Party, said a referendum would be "a good democratic custom".

European Parliament President Martin Schulz denied Brexit would trigger a domino effect, saying the EU was "well-prepared".

But Beatrix von Storch, of Germany's Eurosceptic AfD party, praising "Independence Day for Great Britain", demanded that Mr Schulz and European Commission head Jean-Claude Juncker resign.

"The European Union has failed as a political union," she said.If you ask me, heads should roll in Brussels, starting with Juncker. 
The EU is in a crisis and whether you like it or not, this uncertainty and wave of populism across Europe is going to threaten the global economy and financial markets for a very long time.

After Brexit, we will have to contend with Nexit, Frexit, Italexit, Swexit and one referendum after another, including another one in Scotland. And who knows, maybe Germany will just say enough is enough, we're out of here!

I sent an email to my close friends asking for their opinion. One of them, a cardiologist, replied: "This is really unbelievable.  The worst possible result…. not a clear majority overall with big regional differences between England and Scotland and Ireland. Horrible. It will tear the UK apart and probably destroy the EU.  I don’t know why they make these votes 50+1."

His brother who works in finance stated this: "The problem with the Euro is not Greece or any of the other PIIGS. It is actually Germany who is the 800 pound gorilla in the room. So, in my mind, there are two outcomes: the Euro falls apart or Germany leaves the Euro. Brexit is just the first symptom."

And my younger brother, a psychiatrist, stated this: "It's a binary outcome: either the Euro falls apart, or they tighten up and move towards a true fiscal , monetary, and political union. Status quo is now untenable. I'm betting it falls apart."

In these crazy markets, we need to listen more to psychiatrists and cardiologists and less to financial analysts. I remain short the euro and I'm keeping my eye on the surging yen. So far, despite the volatility, the reaction is one of relative calm (or complacency), but don't kid yourselves, this is the worst possible outcome for the UK, the EU, and the global economy.

One thing is for sure, the Fed is out of the picture for the remainder of the year and possibly all of next year depending on the global fallout of Brexit. Central banks are going to be pumping massive liquidity into the global financial system to limit the shockwaves but they are only doing damage control.

And that global deflation tsunami I warned of at the beginning of the year is now headed our way faster than I even imagined. If you don't believe me, listen to Bill Gross discuss the fallout of Brexit below where he rightly notes populist policies are deflationary.

Gross also discusses the ECB's policy following Brexit and the limits of negative interest rates but as I've stated bonds have entered the Twilight Zone and it could a very long time before rates normalize.

Also, a handful of other European countries say they want a referendum on the European Union. No doubt, Brexit will likely trigger a domino effect in the EU, one that could spell the end of the union.

Lastly, I embedded a Bloomberg clip (late April) where former Greek Finance Minister Yanis Varoufakis talked with David Gura about what he sees as potential Brexit fallout for the European Union and EU's ability to withstand another shock similar to the financial crisis of 2008.

Listen closely to his comments, he is absolutely right on "Brexit speeding up European disintegration, creating a gigantic deflationary vortex in Europe which will consume the UK" and possibly the world.

In this environment, you can forget about any melt up in stocks and you better understand why US bonds (not gold) are the ultimate diversifier. Also, ignore all the talk that the endgame for the dollar bull run is near.

Three years ago, Michael Sabia, the Caisse's CEO warned: "There’s a dark night going on in Europe, a dark and foggy night where bad things come out of trees and bite you. It’s a pretty scary place."

He was right. Welcome to Europe's Minsky Moment and be prepared for a long and volatile road ahead.

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