Uncertainty confirmed in latest Brexometer Index readings from State Street

Jonathan Boyd
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A noted improvement in institutional investor attitudes towards holdings of UK assets represented by findings of the State Street Brexometer Index for the second quarter may not be sufficiently confirmed until data is published for the third quarter, because of ongoing uncertainties in markets sparked by factors linked to currency volatility and interest rate expectations, according to one of the index authors.

Michael Metcalfe, head of Global Macro Strategy at State Street Global Markets, notes that the Q2 survey indicates that the number of institutional investors looking to decrease their holdings of UK assets fell to just 14%, a 10% shift downwards from the 24% noted in the Q1 Brexometer Index. But that Q2 finding was based on data collected up until around 20 April. Since then, facts on the ground have shifted, he aknowleged.

“It is potentially the next set of results that will be interesting,” he said.

“There has been quite a bit of volatility, including the value of sterling – think of sterling as a bellwether of how well things are going. When a softer Brexit looked like it would happen, sterling then was close to its highs, and the survey reflects that and views on the UK economy and how well Brexit negotiations were progressing.”

“But since then, reading from markets, there is much more uncertainty being built in – eg, uncertainty from the Bank of England about rate hikes.”

Metcalfe thinks that the Q3 survey will show people becoming more uncertain again. In the meantime, sentiment remains fluid: if things work out well there may not be the big capital outflows from the UK that investors are concerned about. There is, so far, little evidence of the balance of payments crisis that had been suggested in the wake of Brexit, he notes.

Meanwhile, there are other triggers of uncertainty coming from the Continent, particularly in the past week in the form of Italian politics.

“It is far too early to tell, but if Italian politics become more of a broader euro issue, eg, focus on new elections in Italy and what that might mean for future Italian economic policy, it will prove quite a distraction from the Brexit issue, both in terms of markets and negotiations – adding complicating factors,” Metcalfe says.

“It is hard to see which way it might push it – it might soften the European negotiation stance, or might go in other direction, and make them even more keen to impose their rules – that situation will remain fluid, an added uncertainty in contrast from start of this year when things looked rosy across Europe. Now what were seeing from the turbulence around Italian politics and markets, perhaps some of that euphoria was a bit overdone.”

Metcalfe adds that uncertainty on its own does not necessarily translate into economic downturns or market panics. However, uncertainty does raise the prospects for all possible outcomes. For investors there has been another shift: Metcalfe suggests that markets since the Brexit vote have been exhibiting low correlations, but this has shifted in 2018 with beta returning as a factor with correlations increasing somewhat – an example is how European markets reacted not just to Italian government bonds but also Spanish and Portuguese and banking stocks on 29 May. Systemic risk can raise its head again, and if Italian risk comes back on the table in any serious way that trend could continue, Metcalfe says.

This uncertainty around systemic risk is reflected in the Q2 Brexometer Index findings, in which those with a positive outlook fell from 55% to 36%, while those with a negative outlook for global economic growth rose to 23%. Over a third, 34%, of the institutional investors surveyed for the Index said they believe asset owners will decrease their level of investment risk over the next three to five years, which is up from 6% in the Q1 Index numbers.

And a third, 31%, believe that EU regulatory reporting, such as required under Solvency II and AIFMD will remain an area that businesses will need the most help with after Brexit. About a fifth, or 18% of respondents say Brexit will have “no impact” on their business operating models, according to the Q2 findings, while a similar number, 17%, believe performance and risk analytics will be key areas of business requiring most help after Brexit.

Click here to view the full Brexometer Index results: http://www.statestreet.com/ideas/articles/brexit.html#

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