Nomura Warns "Do Not Underestimate The Global Contagion" From Brexit

Tyler Durden's picture

In a nutshell, Nomura expects the global impact of the Brexit to be more through the financial, confidence and psychology channels than simply through trade. Their warning is to not underestimate the depth and reach of global financial market contagion, which seems to have increased since 2008...

To assess the global impact of this surprise result, it is important to look beyond the trade channel. Once the financial, confidence and psychology channels are taken into account our warning is to not underestimate the depth and reach of financial market contagion to Asia.

A globally coordinated central bank response to a global financial market meltdown is quite likely, such as liquidity support through FX swap arrangements and possible FX intervention, but with policy credibility at such a low it is unclear how successful these emergency measures would ultimately be when there is extreme market risk aversion.

Do not underestimate the global contagion

At first glance, it would seem that the financial and economic impact of this result should be largely confined to the UK, given that its economic size is quite small at less than 4% of world GDP and world imports in 2015. However, we believe that this is too simplistic of a view and that the impact of the Brexit will be far reaching and long lasting, for two main reasons.

First, we expect non-trivial spillover to the euro area economy and financial markets. While the value of merchandise exports from the rest of the EU to the UK is only 3% of the rest of the EU’s GDP1, the UK’s position as a global financial hub – UK financial sector assets account for more than 8x its GDP – leaves the rest of the EU much more exposed to the UK in terms of financial and investment linkages, in part reflecting the UK’s relatively liberalised domestic market and its strong legal framework and institutions.

For example:

  • One-third of the UK’s financial and insurance services exports are to the EU
  • More than half of the UK banking sector’s cross-border lending is directed to the EU
  • Almost half of the foreign direct investment received by the UK comes from the EU2

In addition, Brexit could further inflame anti-EU sentiment in other EU member states, heightening fears of more countries opting to leave the union. It is largely due to these non-trade-related channels that we expect a reduction in euro area GDP growth by 0.5 percentage points (pp) and a weaker EUR/USD.3 While UK share of global GDP is less than 4%, the rest of EU’s share is 18%, so once second-round effects on Europe are taken into account, the global impact is no longer trivial.

Extreme uncertainty is an anathema to financial markets

This extreme uncertainty in the City of London, one of the world’s largest financial centres, is anathema to global financial markets, especially when the global economy is as fragile as it is and as there are limited monetary and fiscal policy easing buffers available to most of the world’s major economies.

At this early stage, great uncertainty exists over just what the Brexit will ultimately mean for the UK economy. For example, how soon and how successful will the UK be able to negotiate with the EU the terms of its withdrawal, and renegotiate trade relationships with 60 non-EU economies where trade is currently governed by EU relationships? Will there be constitutional havoc in amending legislation from EU law to UK law? Will Scotland push for another referendum on independence? Heighted uncertainty and risk aversion is likely to discourage new investment in the UK and weigh on consumer sentiment. The danger is that all these factors – rising inflation, falling asset prices, high uncertainty and weakening private domestic demand – reinforce each other in a downward spiral, dwarfing any positive impetus from a more competitive exchange rate or monetary and fiscal policy easing.

The psychological impact – a link to the US elections

Moreover, one should not underestimate the psychological impact and how quickly markets could link the outcome to a rising risk of Donald Trump winning the US presidential election. As Anatole Kaletsky warned in an article on Project Syndicate (see Brexit’s impact on the world economy, 17 June 2016), the UK referendum is part of a global phenomenon – the rise of nationalist sentiment and populist revolts against established political parties. The demographic profile of Brexit supporters is found to be strikingly similar to that of American Trump supporters. The opinion polls are also strikingly similar: The UK polls showed the Brexit and Bremain camps to be close to neck and neck going into the referendum, as are the US polls on the two main US presidential candidates, Trump and Hilary Clinton. In contrast, investors, judging from recent price action, did not anticipate a Brexit, and option pricing suggests markets are also discounting a Trump victory. The UK betting markets too have downplayed the results of opinion polls: the odds of Brexit were generally about 1-in-3, similar to what US betting markets assign to a Trump victory.

The surprise Brexit result should now increase the credibility of opinion polls – they had indicated a much closer race than the odds published by bookmakers – in gauging how people actually vote. Statistical theory even allows us to quantify how expectations about the US presidential election should shift following the Brexit wins in Britain. To quote Kaletsky, imagine “for the sake of simplicity, that we start by giving equal credibility to opinion polls showing Brexit and Trump with almost 50% support and expert opinions, which gave them only a 25% chance. Now suppose that Brexit wins. A statistical formula called Bayes’ theorem then shows that belief in opinion polls would increase from 50% to 67%, while the credibility of expert opinion would fall from 50% to 33%.” The upshot is that investors are likely to take the results of opinion polls more seriously now and, as such, financial markets could start pricing in a greater risk of a Trump victory in the 8 November election and, possibly, a greater chance of populist insurgencies in the rest of Europe.

The financial tail wagging the real economy dog

In a nutshell, we expect the global impact of the Brexit to be more through the financial, confidence and psychology channels than simply through trade. Our warning is to not underestimate the depth and reach of global financial market contagion, which seems to have increased since 2008. For instance, during the European crisis of 2011, when there were significant fears of EU breakup, Asia’s stock and bond markets became much more highly correlated to the Euro Stoxx 50 and the German government bond yield than over 2000-07 (Figures 1 and 2). And as Hyun Song Shin, economic advisor and head of research at the BIS, recently described it (see Global liquidity and procyclicality, 8 June 2016), “the real economy appears to dance to the tune of global financial developments rather than the other way around”, through wealth, confidence, loan collateral and liquidity effects.

Granted, one potential cushion to a global financial market selloff is expectations of a further delay in the next Fed rate hike, but markets have already significantly priced out Fed hikes for this year (following the Brexit outcome, the market is now pricing a mere 6% likelihood of a Fed rate hike in 2016, down from 58% prior to the EU referendum).

Our US team now believes that the most likely timing of the next Fed rate hike is December (see Policy Watch: Brexit vote will likely delay FOMC rate hike, 24 June 2016). Instead, we believe that the more dominating factor will be renewed concerns over global growth and a likely stronger USD – together they are likely to cause oil prices to continue falling, adding more fuel to the fire of a major risk-off event in emerging markets. A globally coordinated central bank response to a global financial market meltdown is quite likely, such as liquidity support through FX swap arrangements and possible FX intervention, but with policy credibility at such a low it is unclear how successful these emergency measures will ultimately be when there is extreme market risk aversion.

Source: Nomura

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TradingIsLifeBrah's picture
TradingIsLifeBrah (not verified) Jun 24, 2016 2:02 PM

My guess is that by the end of the year we will realize that Brexit was not Lehman, it was Bear Stearns...

nibiru's picture

We have to watch for any shtf moment being blamed on Brexit - this is the tactic they will try to smear and discourage any other freedom movements on the board.

 

Now we need to have another referendum in Europe in 6 months time not to lose momentum! And for the EU it will be the Lehman moment.

http://independenttrader.org/why-brexit-is-sending-seismic-quakes-all-ov...

knukles's picture

Oh, sorta like collateral and margin calls?

glenlloyd's picture

Two things:

1) Anyone who didn't plan for this potential outcome is a moron.

2) Nothing lasts forever, and no one ever said you couldn't leave the EU. Everything has a life cycle.

If the odds of Brexit were 1 in 3 yet the vote ended up in favor of Brexit wouldn't you say your profile of a Brexit voter was inaccurate to say the least? This article is nothing but more fear mongering.

People who are so afraid of what happens when things fall apart are really going to panic and wring their hands when things do start to fall apart...I mean really fall apart.

Vageling's picture

Good stuff. All comes down to point one!  Suckers rather go dummimint.

JerseyJoe's picture

These clowns are suckers too...  And they get paid for this BS!  LOL

 

Our US team now believes that the most likely timing of the next Fed rate hike is December 

Due North's picture

Flip-Flops...cargo pocket shorts....wife-beater.... Oakley's...MAC-10

Harlequin001's picture

and of course the biggest contagion from Brexit is, ... wait for it, ... drumroll please, ... "The Brits don't have to pay for French pensions. Yeah!

Your move Mr Hollande. Guess you need to 'print a few more'...

Countrybunkererd's picture

I hear the POS Bono singing (very reluctantly)...

"IT'S A BEAUTIFUL DAY!!!"

Burn down this elitist cancer called globalism!!

bIlluminati's picture

elitist cancer called globalism!!

You misspelt "gerbilism".

eforce's picture

If the contagion is anything like Contagion (the game in article pic), we won't have to worry about it.

However I don't think we'll be that lucky.

TradingIsLifeBrah's picture
TradingIsLifeBrah (not verified) nibiru Jun 24, 2016 2:16 PM

Yes indeed.  Brexit was really checkmate.  If the Central Banks prop up the markets to keep the status quo going they will show that exiting the EU is not a big deal (more countries will follow).  If Central Banks let SHTF, then they lose control which is the last thing they want.  It'll be interesting to see how they play this one out.  I suspect they will push hard for Scotland to leave the UK to show how "great" being in the UK is, propaganda is going to be key to keeping this boat afloat.

Jeffersonian Liberal's picture

If Trump wins, TPTB will cause the collapse.

They'd like nothing more than to crash the system under someone they can call the epitome of the free-market Capitalist, to claim, "See, when we had a socialist in the WH and gave him complete authority, everything was great. But you stupid patriots had to go and ruin it."

Gab Timov's picture

clinton is already trying to blame things on Trump.

We know the mainstream media is liars by now, so...

Some people don't yet know that, so...

But I think hundreds of millions of people in the US do know the mainstream media is liars who can not be trusted again, so...

MisterMousePotato's picture

Anyone else notice the sudden dearth of mainstream polls showing how Hillary! is trouncing President Trump?

 

Hm. It's quiet. Too quiet.

JerseyJoe's picture

They must shape the thinking of the sheeple early and often...and sheeple want to vote for winners... and who will give them the must free shit. 

WordSmith2013's picture
Global Economic & Financial System
Faces Greatest Challenges Ever!

http://cosmicconvergence.org/?p=15073

FatTony7915726's picture

Sum ting wong with my cream of sum yung guy!

Mind the GAAP's picture

Sum Ting Wong

Wee Too Low

Ho Lee Fuk

Bang Ding Ow

 

Flight Crew

Vageling's picture

If you want to be a funny guy seek better jokes asshat. Asian community doesn't cause problems. They integrate. Some live in their parallel community while others go out. Asians rather solve their own shit. Give cops the subtile finger. In my country even the triads are active. Accept they move in the shadows. Don:t get you.

bIlluminati's picture

More like the North Sea bubble ... or like the decline and fall of the USSR 1989-1991. Juncker, Dragi and Merkel will be as popular as Gorbachev and Yeltsin were in 2000.

TxExPat's picture

Good Analogy, Brexit is Bear Stearns, it's impact on Deutsche Bank's Derivatives is Lehman...

 

N0TaREALmerican's picture
N0TaREALmerican (not verified) Jun 24, 2016 2:04 PM

 

Bah,  in the land of infinte money, the only thing that can fail is a money printing entity itself.  

khnum's picture

Meanwhile in Washington his most munificent excellency Grand Mufti Caliph Barack Hussein Obama has declared open the Stonewall National monument....the USA now has a gay bar as a national monument.

Bill of Rights's picture

Michelle RuPaul Obama must be thrilled

Bill of Rights's picture

And I quote

Fed says it's prepared to provide dollar liquidity.

 

Winston Churchill's picture

They can't print collateral, and they still don't understand the shadow banking system.

Thats where the problems started in 2008, and where they will probably be now.

Just how many times has collateral been rehypothecated this time ?

More than the last, is my guess and London is the epicenter for re hypothecation.

itstippy's picture

+1. From the article:

 

"Our warning is to not underestimate the depth and reach of global financial market contagion, which seems to have increased since 2008."

 

They fixed nothing.  The "Too Big To Fail" financial institutions are bigger and more leveraged than ever; governments are more dependent on deficit spending than ever.   After trillions in Central Bank "stimulus" efforts the expected virtuous cycle hasn't come.  

Thebighouse's picture

Of Course contagion is vast.  Thank Greenspan and his derivatives and shadow banking.

i_call_you_my_base's picture

I'll believe it when I see it. The Europeans will scramble to make deals along with the US and everyone else. The world is at the precipice and no one will risk it all to teach a country a lesson. It would be a pyrrhic victory. And it's doubtful anyone else can really follow suit unless they are printing currency right now.

And if this indicates anything to you about the US election that you didn't know before, then you're an idiot.

E.Shackle.Ton's picture

Did I just hear the ice crack?

nicollimassachi's picture

"The demographic profile of Brexit supporters is found to be strikingly similar to that of American Trump supporters. The opinion polls are also strikingly similar: The UK polls showed the Brexit and Bremain camps to be close to neck and neck going into the referendum, as are the US polls on the two main US presidential candidates, Trump and Hilary Clinton."

 

Ironinc that the last day at my job is the last day that UK is within the EU : /

N0TaREALmerican's picture
N0TaREALmerican (not verified) nicollimassachi Jun 24, 2016 2:23 PM

Re: Ironinc that the last day at my job is the last day that UK is within the EU

Voluntary, or involuntary?  

Vageling's picture

Your last sentence confuses me. Cameron packed his bags. Article 50 is not 'activated' yet. For now it's business as usual. UK is still a EU member nation. Council of the EU is already scheming how to bully the Britons. If that's not a sign of pissed off fascist dictators. UK is still in the EU. Don't buy the scaremongering! From the moment they apply for Article 50 the 2yr clock starts ticking but they are still a EU member nation. Dunno what BS they fed you, but it's BS!

William Finn's picture

The EU is going to look like the Big East or the WAC 3-4 years ago.  Everyone will want to be in a surviving conference and will run like rats to cheese in order to protect themselves.

 

Go Horned Frogs.

Emergency Ward's picture

Fearmongering at its finest.  Scare the market down, buy, and next month sell into the rally when BREXIT is out of the news cycle.

Vageling's picture

The unexpected happened. I admit I was wrong and I'm glad I was. Though this is no cat in the bag. The actual secede is sill far away. And the sore losers are already at it. London yapping about a secede. The democratic process hating socialist don't stop untill they enforced their will on you. Buncha slaves yapping democracy. 

Grandad Grumps's picture

I think that the most important thing to be wary of is that the Brexit vote was intended to make the people believe that anything that happens now is a result of populism and that when bad happens the zionist elitist globalists will point at the populist victory and say: "See what you have caused. You cannot be trusted to make decisions for yourself. You need to be fully dependent on strong and experienced hands who know what is best for you ... silly children."

It is very possible that the populist victory in the UK was arranged so that the globalists can achieve a greated goal more easily. I have often wondered why the UK was allowed to keep its own currency. Now, I think it may become clear that it is precisely for this time.

Do not be deceived into believing that the political zionist elitists are not fully in control. They still occupy all of the positions of power... at least in the west.

Niall Of The Nine Hostages's picture

Funnily enough, Britain will now take her place with Israel and Russia among the free nations of the world.

Israel, who had nothing to gain and much to lose from Britain's falling into Muslim hands, will benefit greatly from England's coming to her senses.

Israeli financial markets were closed today for Shabbat, but we'll see the Brexit impact on Sunday. Expect only a small impact, if any. The best stock markets to have your money in today were the ones outside the EU.

 

TuPhat's picture

This is all scare tactics imposed by the elite and nwo proponents. Britain already used the pound so the financial relationship to the euro will not change much. Trade is still trade and the agreements on trade have not been retired. A lot of fuss for no reason.

earleflorida's picture

if oil bounces back[?], and... its all about "OIL"! those nasty saudis are a, 'hurting-kinda-thingy', could, and in all probability would/will have[?] to reverse their thinking! if they decide to cut production the markets will react in kind...[?]

gold and oil always go up in tandem.

just a thought, and...

jmo

Ps. 3% loss is no Lehman moment, or a 2% loss on monday only amounts to a normal pullback of ~ 5%

again JMO

Panic Mode's picture

Don't blame me for voting for Brexit. If you (Japan) have a healthy economy and not allow printing and allow restructuring, my action will not affect you today at all. 

It's your own doing. This applies the same to the countries joined the big daddy EU.

Omega_Man's picture

so EU plan was for UK bankers to take over in other nations??? good riddenace 

the grateful unemployed's picture

if you have to guess todays reaction was right out of chicken little. the fearmongering continues. its also likely that the government (now resigned) used public funds to juice up the polls on the Remain side, to discourage the Exit voters, and that strangely the traders positioned themselves according to the Ladbroke bookies, a bookie only takes the bets and sets the odds. if there is some guilt here I say lets take a look at Cameron who set up the global trade for a massive wipeout to paint the tape on the debate to the Remain side. all this guff about psychology, pure drivel, the people in power wanted Remain and they set everyone up for a huge loss, although it will be curious forensically to see if any of the firms put on large positions ahead of the event, the general market got caught leaning, so obviously if the big firms knew Exit was live, they didnt share the info.

Elco the Constitutionalist's picture
Elco the Constitutionalist (not verified) Jun 24, 2016 3:51 PM

Brexit affects the markets, because it signals that the electorate is willing to think long term and suffer short term pain to achieve sustainability.

The entire global financial system is predicated on betting the opposite of that.

Niall Of The Nine Hostages's picture

History will record that the only losers from Brexit were a few thousand speculators who bet big on Remain, and wound up having to explain to top brass on Friday how they didn't see this coming and what they plan to do about it. Count on banker suicides---some even genuine---to spike in the next little while.

For the rest of us, the sun rose this morning as usual, telling us it was time to get up and go do something useful to earn our daily bread.

Happy St. John's Day.