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Queen’s Global MarketsA PREMIER UNDERGRADUATE THINK-TANK

Brexit

P. Graham, P. Mazurek, G. Randjelovic, S. Robert

10.18.2016

A Reflection & Looking Forward

2

AgendaWhat we will be discussing today

1 Social Reasons For Brexit

2 Immediate and Future Economic Impacts

3 Effects on Capital Markets

4 Political Impacts and the Future of the EU

5 Outlook

3

Distrust of Incumbent Politicians

Low Voter Turnout Anxiety Over Immigration

• David Cameron saw a drop in his approval ratings from the moment he approved of the

referendum. His numbers continued to tank until he resigned, making him a very poor figurehead

for the Remain side

- On the other hand, Boris Johnson, the figurehead for Leave, was very popular from his time as

mayor of London

• Polls suggest that the vote succeeded

because of significantly greater turnout for

older generations, shown by Leave districts

being predominantly older

• Globalisation, immigration, and multi-

culturalism were the main issues behind

Leave

- Recent geopolitical events such as the

Paris attacks and June 12th nightclub

shooting gave rise to caution

Sources: YouGov, IFS, The Independent, BBC

Society Before BrexitA Complete Collapse in Trust of Leadership

4

David Cameron Boris Johnson

Politicians Out of Favour“Remain” Activists Were Out, “Leave” Activists Were In

Sources: YouGov, The Independent, BBC, ComRes

• Set the groundwork for the referendum in

late 2015

- Set the official date in February 2016

• Campaigned heavily for Remain as a

figurehead of the pro-EU movement

• Significant drops in approval and trust

ratings leading up to the referendum

• Extremely popular mayor of London from

2008-2016

- Campaigned as a figurehead for Leave,

alongside politicians like Nigel Farage

- 45% of Britons believed he told the truth

about the EU Referendum, compared to

Cameron’s 21%

20

30

40

50

60

70

15/05/2015 12/6/2015 10/7/2015 27/10/2015 15/01/2016

David Cameron Approval

Approval Disapproval

20

30

40

50

60

70

19/4/2013 8/4/2014 13/08/2014 18/12/2014

Boris Johnson Approval

Approval Disapproval

5

Why People Voted Leave Who Voted Leave

The Issues & The TurnoutImmigration, Globalization, Liberalism At the Heart of Leave

Sources: Lord Ashcroft Polls

• Exit polling run by Lord Ashcroft Polling

provides data on why people voted to Leave

• The likelihood of voting for Brexit if you

strongly disliked one of the following terms:

- Multi-culturalism (39% disliked): 81%

- Social liberalism (35% disliked): 80%

- Immigration (54% disliked): 80%

- Environmentalism (26% disliked): 78%

- Feminism (22% disliked): 74%

- The Internet (6% disliked): 71%

- Globalization (36% disliked): 69%

- Capitalism (43% disliked): 51%

0

20

40

60

80

18-24 25-34 35-44 45-54 55-64 65+

Votes By Age Group

Leave Remain

0

20

40

60

80Votes by Race/Religion

Leave Remain

6

Wealth Transfers to Other Countries Sovereignty

European Economic IntegrationVoter’s Frustrations With The Single Market

Sources: Bloomberg

• Poor economic performance of the

European Union (EU) and concerns about

wealth transfers to other EU countries:

- In 2015 the UK paid £ 13 billion (C$20

billion) to the EU and received £ 4.5

billion (C$ 7 billion)

- Wealth and employment disparity

between member states

• Maastricht Treaty of 1992 transferred

powers from parliaments to Brussels

• Free movement and immigration – the EU

requires that member countries allow the

free movement of factors of production

(including labour)

- Net migration into the UK was 330,000

people in 2015, which the Leave

campaign argues is far too high (their

target is less than a third of this total)

• Refugee crisis only added to these fears

-2.00%

-1.00%

0.00%

1.00%

2.00%

3.00%

4.00%

Mar

-10

Jul-

10

No

v-1

0

Mar

-11

Jul-

11

No

v-1

1

Mar

-12

Jul-

12

No

v-1

2

Mar

-13

Jul-

13

No

v-1

3

Mar

-14

Jul-

14

No

v-1

4

Mar

-15

Jul-

15

No

v-1

5

Mar

-16

YoY GDP Growth Rates

UK Eurozone

7

The Tradeoff

An Uncertain Future

Have the Cake and Eat It?Britain Will Have to Choose Between Sovereignty and Trade

Sources: The Financial Times

• Norwegian model – no participation in

political structures but access to the EU

market. Pay into the EU budget and accept

free movement of people

• Swiss model – arrangements governed by a

number of bi-lateral agreements which

results in access of EU market for most

sectors of the economy. Contributes to EU

budget and accepts free movement of

people

• Canadian model – Comprehensive Economic

and Trade Agreement (CETA), when signed,

allows Canada preferential access to EU for most

economic sectors, without financial commitments

or free movement of people

• Hard Brexit – no preferential access to EU market

and no political commitment. Relationship would

be governed by World Trade Organization rules

• The future impact of Brexit is unknown. Theresa May, the new UK Prime Minister says she submit

Article 50, which triggers Brexit by March 2017. The UK and the EU then have two years to

negotiate a new arrangement

• Overall the effect of Brexit on the economy will be negative: limiting trade and the supply of

labour will have a negative impact on the economy

- Just how bad the impact will be will depend on the severity of Brexit

8

The Balance of Payments A Depressed Pound Gives an Opportunity to Eliminate a Long Standing Current Account

Deficit

Sources: The Reserve Bank of St. Louis

-6%

-5%

-4%

-3%

-2%

-1%

0%

1%

Jan

-88

Mar

-89

May

-90

Jul-

91

Sep

-92

No

v-9

3

Jan

-95

Mar

-96

May

-97

Jul-

98

Sep

-99

No

v-0

0

Jan

-02

Mar

-03

May

-04

Jul-

05

Sep

-06

No

v-0

7

Jan

-09

Mar

-10

May

-11

Jul-

12

Sep

-13

Current Account as a Percentage of GDP

Short-Term Impacts

Long-Term Impacts Current Account as a Percentage of GDP

How to Capitalize

• Uncertainty creating volatile financial

markets

• Risk of decrease in GDP and increase in

inflation

• A depressed pound will create an

environment where exports are cheaper

• Britain must find a competitive advantage in

the long term to export

• Britain cannot believe that they can

completely sidestep the EU

• Unless Britain finds a good substitute to the

trade that the EU provided, they will likely

be be sustaining lower growth in the long

term

• Britain must also be very careful in how it

limits its immigration – the possibility of a

demographic crisis does exist

9

FX and Equity Market Reactions – Timeline

Market Reaction to BrexitA harsh sell-off met with an aggressive buying opportunity

Sources: Bloomberg, Financial Times, Economist, The Telegraph

• Uncertainty: discouraging, portfolio flows, inward

investment, and domestic firm investment

• UK current account: reduced net capital inflows

• Loss of single market: more costly to sell goods and

services to Europe, reducing the demand for sterling

at Europeans will consequently buy less

• Reduced growth expectations; potential rate cut

10,000

12,000

14,000

16,000

18,000

20,000

1.10

1.15

1.20

1.25

1.30

1.35

1.40

1.45

1.50

1.55

1-Feb-16 1-Apr-16 1-Jun-16 1-Aug-16 1-Oct-16

GBP/USD FTSE Index

February 20: Date of

referendum

announced

April 3: Vote Leave

announced as official

campaign

May 27: Purdah

Starts1

June 7: Deadline to

register to vote

June 23: GBP/USD closes at 1.4877

(94% of 52 week high)

June 23/24: Polling

day / National

declaration of

referendum result

October 18: GBP/USD

closes at 1.2293 (17%

below June 23rd level)

Pound Sell-off Market Rebound

• FTSE 100: 70% of companies revenues within the

index is derived abroad, increasing profitability

• Dramatic sell-off: Investors saw bargain

opportunities in many constituents

• FTSE 100 masks the strain on the underlying

fundamentals of the domestic economy

‒ Is about flat on a currency adjusted basis

10

Continued Volatility Recent political developments have, for the time being, broken a long-standing

relationship between Sterling and gilts

Sources: Bloomberg, The Telegraph, BoE

Increased Downward Pressure

Historical Relationship Between Sterling and Gilts

Central Bank Intervention

1

1.1

1.2

1.3

1.4

1.5

1.6

1.7

1.8

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

18-Oct-13 18-Jul-14 18-Apr-15 18-Jan-16 18-Oct-16

10Y Gilt Yield GBP/USD

1

1.1

1.2

1.3

1.4

1.5

1.6

0.00

0.25

0.50

0.75

1.00

1.25

1.50

20-Jun-16 30-Jul-16 8-Sep-16 18-Oct-16

October 18th, 2013 – August 31st, 2015:

R2 = 0.89

Around October 1st, relationship between

Gilt yields and the Sterling dramatically

becomes inverse

• After stabilizing briefly after Brexit, the sterling

continued to sell off after warning of “hard Brexit” or

“no Brexit” from EU President, Donald Tusk

• Theresa May identified two main constraints to EU

negotiations:

1. Controlling migration

2. Ending European Court of Justice jurisdiction

• The previously inverse relationship between Gilts

and the sterling recently flipped to a parallel sell-off

• Debt markets and the sterling initially reacted to the

25 bps rate cut from the BoE immediately after Brexit

• The falling sterling has lead to a bond market sell-off

as returns are slashed for overseas investors

accompanied by a dramatic pickup in inflation

11

Historical Probability of a Rate Hike at December Meeting

Where to Look?Investors are quick to price-in market expectations upon release of an additional data

point

Sources: Bloomberg, Financial Times, BoE

Increased Inflation Eyes on the BoE

0

10

20

30

40

50

60

70

80

90

100

1-Jan-15 4-Apr-15 6-Jul-15 7-Oct-15 8-Jan-16 10-Apr-16 12-Jul-16 13-Oct-16

(%)

Probability of rate > 0.25

Probability of rate = 0.25

Probability of rate < 0.25

90%

10%

• Inflation rose 1% in September, the biggest rise in

two years and up from 0.6% the previous month

• Reducing pressure on extremely loose monetary

policy as the BoE may have less incentive to cut

interest rates and extend the gilt purchase scheme

• Current account deficit may also play a role as market

participants push the U.K.’s cost of debt upwards

• Lack of cohesion between the BoE and the Prime

Minister’s office only provides more reason for

uncertainty within markets

• Combination of a “hard Brexit” with extremely

relaxed monetary policy in detrimental to the sterling

– Can potentially act as a self-inflicting cycle

12

Impact on Major Political Parties

UKIP Scotland

• Theresa May’s faction represents a slim majority – 58% of Tories voted to Leave

- Staunch, nationalist fueled divide mirrors GOP internal conflict in the wake of the Trump

campaign, may fuel party instability and potentially weaken party positions

• Majority of Labour supporters voted Remain, albeit not overwhelmingly – 63% vs 37%

- Lab leader Jeremy Corbyn has been ambivalent towards Brexit and emphasizes moving on

- No strong movement to revise or abandon the vote

• Brexit: UKIP’s raison d’être?

• UKIP seeks to position itself as a mainstream

European far-right populist party

• Large leadership upheaval following

resignation of long-time leader Farage

• Impact of vote on party popularity is

uncertain – depends on voter attitudes

• Scotland voted remain 62%-38%

- SNP supporters voted remain 64%-36%

• Brexit represents “violation of agreements

made by UK government post

independence referendum”

• SNP leader Nicola Sturgeon is committed to

pushing independence in face of vote

Sources: BBC, Bloomberg, The Guardian, The Independent

Domestic Political ImplicationsLeadership and party shifts

13

Euroscepticism The Periphery

European Political ImplicationsDiscord across the continent

Sources: Al Jazeera, BBC, BFP, Europa, London School of Economics, Pew Research Institute

• Euroskepticism on the rise

- Part of increase in popularity of far-right

national movements with similar appeal

• Brexit precedent may spur further broad

increases in Euroskepticism

• Future growth of Euroskepticism in face of

more migrants and poor economy

• EU viewed more positively amongst

“periphery nations”

• Emerging economies dependent on EU

• Inter EU immigrants face challenges

moving forward

• Potentially beneficial towards EU

candidates

14

Nationalist Right in the West

Nationalism Globally

• Implications of successful nationalism have potential to fuel similar movements across the West

- Brexit symbolic of those shunning thinned political spectrum in Europe and North America

• Growing opposition to globalization and it’s chief tenets

- Low western approval of immigration despite continued high levels of migrant flow

- Protectionist measures increasingly popular among western workers

Sources: The Economist, Forbes, Huffington Post

Global Political ImplicationsFear of a globalized planet

• Implementation of nationalist policies and nationalist-oriented leaders throughout the world

- Ruling parties in countries such as Japan, Russia, India, Philippines describe themselves as

nationalist

• Part of a shift in global conservative politics and traditionalist politics

- Greater tendency towards nationalism, national integrity and authoritarianism

- Weaker support of classical conservative and libertarian ideas