Richard Kelly, Head of Global Strategy at TD Securities, joins Kim Parlee from the UK to talk about the “Ifs and Buts” around Brexit; how it will affect the European economy, and why he believes there is a one in three chance that the results of the referendum could be severely watered down or changed.
Well, since then, markets have bounced back as attention shifts to the mechanics of how Britain will leave the European Union and what that divorce might actually look like.
Earlier, I had a chance to speak with Richard Kelly.
He's the head of Global Strategy at TD Securities.
[COUGHS] He's based in London, and I asked him, now that we're a few days into post-Brexit trading, is there more clarity now than there was a few days ago.
I think that's the area where you certainly have no clarity whatsoever now.
I mean, the politics, as you said, whether a civil war or total upheaval, every question is being asked.
You know, you don't have a leader for the Tory Party.
So that competition is underway.
You have a leader for the Labour Party that isn't liked and basically has been revolted by 80% of his own party trying to vote him out.
The problem being, even if they do that, it looks likely that you'll go back to the Labour supporters, not just the MPs that would vote for a new leader.
And it's still likely he would be voted back in.
So you still have a tremendous uncertainty there within those parties.
Even though the referendum passed by the people gives a slight majority to want to leave, the overwhelming majority of MPs are still in favor of remain.
So they have to decide whether that sort of existential issue is something they're going to vote on or whether they simply are going to try and protect their jobs, which would argue for moving ahead with the leave camp.
You bring in the Scottish side, the fact that they overwhelmingly voted to remain and wanting to go through there.
How will the EU relate to everyone?
How will these negotiations actually take place?
I think the politics is a total chaos right now in terms of what you're looking at.
And so I think that's where nothing has become more clear on the sort of medium-term macro scenario, the nearer term political scenario, which is what you need to try and figure out as an investor where are we going over the next two or three years when it comes to UK assets.
When you list off all the things you just talked about-- I mean, the political complexity is almost mind-boggling.
But I want to go back to a note that I saw that you wrote, and your group talked about how this is a shock not a crisis.
Tell me why, with all that political complexity you just talked about, this is not a crisis and just a shock.
Well, I think you had some people initially try to say that this was Europe's Lehman moment.
When you are looking at what's going on, Lehman Brothers 2007, 2008 and subprime was about, will the banks survive?
If you go into the eurozone crisis, that was about, will the peripheral economies in the eurozone survive?
No one here is questioning, will the UK survive?
What we're debating is, will GDP be 1 percentage point lower or 2 percentage points lower over the next couple years?
That is a very different debate to have.
That is a debate about sort of levels and longer term fair value.
It may be very uncertain what sort of world you're going to be in.
I think it's very much almost an equity-biased world, because there will be winners and losers, just like there are in any sort of free trade agreement.
So you're trying to define who can win, who can lose.
And given you don't know where these rules will go, it becomes very difficult.
But overall, that does balance some of the downside there.
And so I think that's how you want to look at this.
You can also compare it to July and August last year.
In January, when we had the financial conditions tightening, largely because of what was going on in emerging markets in China, that made it more expensive for you to finance debt.
That created some uncertainty, and that was a very near-term drag.
You may see some of that tightening now.
We have seen some of that tightening now, but what you're going to see more of this time is a change in longer term economic expectations in planning by businesses in Europe.
So it is a different sort of shock.
It changes your growth expectations, but it is not an existential crisis.
So without those changes, though, in long-term growth expectations, when do you think that the market's going to be able to fully price that in?
I mean, what data points are you going to be watching to say, yes, this means it's 1% not 2% growth, or here's the second order effects we're seeing on a rising dollar on, for example, emerging market debt, or China, or those types of things?
I mean, this is such a complex piece here.
Right, and I think this is why you're going to see a lot of volatility in the markets over the coming months, because this shock is almost more difficult to price in.
So we've seen markets for the first couple days price in similar scenarios to what we saw in August and January over the last year of a financial condition side.
But given we didn't see much tightening on the funding and liquidity side, what was going on in between banks, markets have tended to move away from that.
I think now they're also trying to fade the sense that, is this just a UK shock, if we're talking about UK firms that need to decide where they're going to be headquartered, how much CAPEX spending, how much hiring they're going to be doing.
Do I need to worry about that as a US investor, as a Canadian investor, as a Japanese investor?
So I think you're starting to see markets question that.
I do think, ultimately, you will see a bit more of that contagion than perhaps markets have priced in, but I think what you're going to have to see is it's going to be touch and go.
You will see markets try and fade some of that.
And then you'll see the data come in and prove them wrong, and we'll have to reprice lower.
Then we'll probably overshoot, because they may get over-exaggerated with one or two data points.
And I think we're going to have to settle back to a point, probably over the next six months.
It's going to take us to price a lot of this in, simply because there's the other debate of, when does the UK actually trigger Article 50, which is what starts the two-year process, when we can actually start negotiations and know what does that long-term look like.
I think when you're looking at some of the things that maybe you have a better conviction on right now, there is a reasonable chance that the Bank of England will not hike rates in this decade.
I think that is something that you look at, but what you can't tell is how much easing is coming in the near term, when do the shifts happen, which industries will be winners and losers overall at the end of the day?
It's-- my jaw dropped a bit when you said the Bank of England won't be raising for a decade.
I mean, I understand why, but when you hear-- a decade is a long time.
So it's interesting that you say that.
Last question for you, Richard, I believe you've come out and said you believe there's a 1/3 chance that the effects of this referendum could be either reversed or severely watered down.
Can you tell me a bit about that?
Right, and I think that's part of the political uncertainty on this.
What you're seeing is, it is a very divided country.
We don't have any new leadership and the parties themselves are trying to jockey and decide exactly how this happens.
I think what you could have happen over time is-- this referendum was decided without any sort of real facts.
It was hopes of, this is how we will negotiate.
This is what we will try to do.
These are the benefits that you will have.
What you could have now is over the next 6 months, 12 months, 24 months, as these things are going on, as the facts become realized, well, then the UK may find itself having to have an early election, having to actually have a new referendum and say, these are the specifics on the table.
You voted for your intention to want to leave the EU.
These are the facts of what will happen to you.
This is what it will cost you.
These are what the benefits will be, and then see do people want to vote for that, or do you want to remain in the EU?
So I think you have to put that up as a reasonable possibility, given the tremendous amount of uncertainty that's going on right now.
You will see a lot of political change, but what is clear is that the country is still very divided on to what they ultimately want.
They were very unhappy.
That's what drove this vote, but it's not clear that they will be happy with the outcome they can negotiate.
Richard, great insights.
Thank you so much for joining us.