Broker's View

As uncertainty reigns, what will markets get wrong next?

After the shock of Brexit, the already nervous global economy has just become even more unpredictable

PUBLISHED : Thursday, 07 July, 2016, 4:21pm
UPDATED : Thursday, 07 July, 2016, 10:41pm

The UK’s vote to leave the European Union two weeks ago, which largely caught the market by complete surprise, has caused a new level of disquiet in the global economy.

This is not just because of the direct impact of the vote, but also because investors and policy makers will be less optimistic in their forecasts of other upcoming global events.

Later this year, the US has its general election, and Italy a referendum on constitutional reform.

Next year, France has presidential elections, Germany federal elections, while in Asia-Pacific elections are taking place in New Zealand, South Korea, and, of course, in Hong Kong.

While mainland China is immune to uncertainty in this particular regard, the ongoing concerns about a potential hard landing are adding to the global unpredictability.

“We think one of the implications of the Brexit vote is that markets, companies and consumers

will attach a much higher degree of uncertainty to other looming political events,” said a research report from HSBC, written by Janet Henry and James Pomeroy.

Even though markets expected the UK to vote to remain in the European Union, investment activity in the UK slowed heavily in the months leading up to the referendum.

The HSBC report said there are concerns this will now translate into wider global uncertainty.

The HSBC report added, “elevated uncertainty tends to hit growth primarily through reduced investment spending, lower household consumption of durable goods, and on the supply side via firms holding back their employment plans”.

This has a follow-on effect on decisions made by policy makers.

Another rise in interest rates by the US federal reserve is now looking unlikely, while the Bank of England is strongly expected to cut interest rates in the near future.

As for China, Premier Li Keqiang said during the World Economic Forum in Tianjin last month: “Brexit has showed its impact on the international market and further increased uncertainties in the global economy.”

But the uncertainty now existing will have a second order effect on Chinese and other Asian policy makers as they respond to lower global growth.

The downturn in global trade continues to dampen the outlook for Asia’s export-oriented economies, and Brexit uncertainties could worsen the slowdown, according to a separate report from Standard Chartered.

To partially offset the drag on growth, we expect both monetary and fiscal policy settings to be more accommodative. But the balance remains precarious
HSBC analysts, Janet Henry and James Pomeroy

Asian exports have contracted for the second year running. This is adding to excess manufacturing capacity and increasing disinflationary pressures for key exporters such as South Korea, Taiwan, Hong Kong and Singapore as well as the manufacturing sector in China,” it added.

China is continuing to rebalance its economy away from manufacturing, but such industries nonetheless remain a very important part of the Chinese economy.

In June, the official manufacturing PMI stood at 50, the exact level dividing expansion from contraction, while the Caixin manufacturing PMI, which is traditionally more influenced by export-related weakness, fell to 48.6.

HSBC’s Henry and Pomory are now expecting merchandising exports [in China] to contract by 8 per cent in 2017, an even bigger fall than the 4.2 per cent expected in 2016.

“This will likely weigh on manufacturing investment, particularly at a time when business sentiment remains fragile,” they said in their report.

“To partially offset the drag on growth, we expect both monetary and fiscal policy settings to be more accommodative. But the balance remains precarious.

“An extended period of uncertainty could weigh on sentiment and growth beyond what we are currently forecasting, potentially requiring more timely and aggressive policy response.”