While the vote to leave the EU came as a bombshell to all, Brexit may not turn into the type of crisis that will have a long-lasting impact on the global economy. David Tulk, Head of Global Macro Strategy, TD Securities, explains.
An unexpected outcome from a market perspective.
Fast forward to today, we now have a couple of days of trading under our belt overseas.
What has developed politically over the weekend?
Yeah, I think the big question is how the political side of it resolves itself, and we're left with a little bit of a vacuum.
There's uncertainty in terms of when we would see David Cameron resign.
He initially had talked about an October horizon.
Now that seems to be something that may happen a little bit sooner.
And then really, who steps in?
And then when does the UK trigger Article 50, which is the formal proceedings to begin the negotiations with the rest of EU?
You've also got, I think, over the weekend we heard about 3 million people have signed onto a potential petition, I guess, referendum.
Scotland wants to have another referendum.
You've got all the Labour ministers resigning.
The headlines seem quite disconcerting.
And this is one of the issues that I think we really need to struggle with is that it adds a tremendous amount of uncertainty into an already uncertain environment.
So at least with the politics side, hopefully some of that starts to come into a little bit better focus over the next couple of weeks, because then at least we can start shifting then our attention back to the underlying economics and some of the negotiations that will have to take place, which will be very difficult negotiations.
So as politicians are important parts of that, the uncertainty that we've seen certainly with discord within the Conservative Party, but also within the Labour Party, and some of the questioning we see at least even within UKIP, it's creating a huge issue here, where we just don't have any sense of where politicians are taking us.
In the next week, I know we're going to be getting a lot of updates in terms of what is happening politically.
And I'm just going to say, a lot's going to be going on, and we have to figure it out.
Let's talk a bit about the economic fundamentals.
What should we be watching?
What are the indicators we should be looking for that this is becoming something we should be more concerned about or less concerned about?
Yeah, I think there's a couple of things we need to keep an eye on.
First off, just looking at how the market trades.
And this is something that can certainly cause financial conditions in other countries to deteriorate.
So the UK in its own matters in terms of trade with the rest of Europe, but when we look at the links, for instance, to the US economy, they're fairly small.
But where that can become a greater issue is if we see financial conditions weaken in the US, so either equities continuing to fall, even the US dollar strengthening, as it does tend to benefit from some of that flight to quality flows.
If that starts to become more pronounced, that's certainly an indication that maybe the US starts to slow under its own momentum.
We also would need to look at some of the economic data, probably first from survey data, to suggest if firms in the UK are hesitant to the point where they stop hiring, they stop investing, and certainly some of that hesitation is warranted.
We could see that same type of dynamic unfold in the rest of Europe.
So from that perspective, it probably takes a couple of months for that economic data to be released for us to gauge that impact.
But where we're watching obviously more carefully and that has a higher frequency is just in terms of how financial markets perform and what that could dictate for the rest of the economy.
You and your colleagues have put out a research note, and I thought this was the phrase that jumped out at me, "This is a shock, not a crisis." Why?
Yeah, and I think this is really what we would compare to from what we've seen from other crises, to be honest, over the last couple of years.
So what differentiates this, for example, the Lehman Brothers crisis was that liquidity is still abundant.
So this is not something that stands a systemic risk to other economies at this stage of the game.
It's certainly a shock in the way that markets are trying to understand the politics, and it sets the stage for difficult negotiations and a prolonged period of economic adjustment potentially within the UK and probably other parts of the world as well.
But it doesn't have that feeling of something that impacts everybody equally at the same time.
So from our perspective, that is why it's probably more of a shock at this stage as opposed to really sowing the seeds of a crisis that will have a prolonged impact, in our mind, on the global economy.
We are seeing, though, the immediate impact obviously.
Pound, obviously, has been sinking, sinking again in trading.
Do you expect to see these dynamics continuing, the flight to safety, and getting away from risk-on assets?
Yeah, I think so.
Well, there will be a tendency to certainly seek safety at this point, especially given some of the political uncertainty, especially given the nature of the market that had basically gone into this event with pricing in absolutely-- or very little chance of a Brexit.
So from that perspective, there needs to be a reallocation of resources, trying to understand more fundamentally where things sit.
But at some point, I think some of the wider fundamentals start to reassert themselves.
So for instance, when we look at the US economy, under the surface it's not doing so badly.
So if we can shift our attention back to that, maybe some of this selling pressure will start to wane, and we'll start to see where relative pockets of value open up.
But in the interim, again, when we reflect on any number of different sources, whether it's political uncertainty, whether it's economic uncertainty, you just try to find what's liquid and what's safe, and that certainly stands to benefit treasuries, US treasuries, the gold market especially.
So those are where you're seeing the main moves at this stage.
Let's take this from, if we could, a Canadian perspective, and talk about what the impacts are on us, our currency, our economy.
You see the loonie selling off.
Yeah, to be honest, it hasn't been as bad as what we would have initially feared.
So there's a couple of moving pieces under there.
Certainly Canada is not a large enough market to really serve as a safe haven, so it tends to struggle as collateral damage in terms of the flows into the US economy.
And we also tend to benefit from at least some of the flows into precious metals, which can support certain aspects of Canadian industry.
But on the flip side of that, we also struggle obviously with the exposure to the oil sector, which is treated as a risk-off asset in this environment.
So there's a lot of crosscurrents that have certainly, in our view, probably stand to weaken the currency a little bit further.
So at this stage, there's a little bit of hesitation.
I think the focus really on the part of the market is on other markets, to be honest.
So to see that flow through to Canada is a bit of a side story.
But as I think some of this unfolds over the next couple of weeks, we would expect to see, at some point, some weakness showing up in the Canadian dollar.
And Bank of Canada, what kind of reaction do you think we're going to get from them?
I think they're certainly taking a wait and see approach.
You've seen that from other central banks as well.
What the Bank of Canada ultimately cares about is the degree to which the shock potentially propagates through to the real economy.
The direct linkage between Canada and the UK economy is fairly modest, and I think the shock will be reasonably well handled.
But where we see maybe a greater source of concern is if what we find in the UK economy starts to filter into the US, and that's obviously much more important to the market for the Canadian economy.
So if that starts to become a greater source of concern, then the Bank of Canada might have to respond to that.
David, thank you very much.
You're very welcome.