Notes From Underground: A Hard Brexit Is Going To Fall?

The economic fallout from a “hard” Brexit has been debated in the media for the last few months. When I say “hard Brexit,” I mean that the U.K. leaves the European Union without any deal about trade rules, movement of people or any other binding treaty rules concerning the contemporary EU/U.K. relationship. I have refrained from forecasting outcomes because they are beyond the scope of economic analysis since it requires using models built of questionable assumptions. The British have a long history of economic intercourse intertwined with the lines of commerce from its empire.

Yes, there’s a cat’s-cradle of economic and social ties that exist between Brussels and London but will these just simply disappear? That’s highly doubtful for in today’s modern economies global transnational corporations have developed tightly linked supply chains based on the high speed modes of transportation, helping to sustain just-in-time delivery. The BOE and ECB have presented dire forecasts for the U.K. but again, those are based on models with a poor record of forecasting.

Bank of England Governor Mark Carney has been predicting bad outcomes for the U.K. economy before the June 2016 BREXIT vote and has been consistently wrong. The U.K. economy, while not robust, has performed better than the EU economy as a whole.

In the London Telegraph on Jan. 31, there was an opinion piece by Ambrose Evans Pritchard titled, “Economists Angry At ‘Dangerous Handling’ of Brexit By EU.” The pieces cites a report by the influential IFO Research Institute and “warns that Brussels may be deluding itself in thinking that the EU has the upper hand in all respects.” The IFO is led by two German economists, Clemens Fuet and Gabriel Felbermayr, and the outcome it desires is a European Customs Association. Yes, the modeled outcome can be criticized for similar reasons for not knowing the assumptions upon which their work is based but it makes the foregone conclusions of dire outcomes for the U.K. suspect.

The BREXIT outcome is too dynamic of an event to state with certainty that the U.K. will suffer more than other actors. Will the weak POUND, lower taxes and a certain lessening of the Brussels bureaucratic regulations be a BOON to the U.K.? Will the Trump Administration act to move the U.K. to the front of the queue in a free trade association? We don’t know, which makes a “HARD” BREXIT a difficult investment forecast. But Europe OUGHT to be cautious for if the IFO research has validity, poor outcomes for the German economy can push Europe into a severe recession. Maybe Teresa May has a stronger hand than the popular narrative suggests. So much of what will ultimately play out will be decided in Berlin. The Germans are highly intertwined with the U.K. economy and, even more importantly, the Bundestag has the fiscal wherewithal to be able to cut taxes, as well as ramp-up domestic spending in an effort to prevent too severe a slowdown.

Even with negative interest rates in the EU, the Germans have room for fiscal expansion. What do I mean? Investors pay the German government for the privilege of lending it money. Based on EU rules of stability and growth, Germany is the only major European economy with the balance sheet required to deploy fiscal stimulus. The problem is that just this week Finance Minister Olaf Scholz noted that calls for increased fiscal stimulus will not be answered without consideration of “Schwarze NULL,” or black zero, which adheres to former finance minister  Wolfgang Schaeuble’s concerns for balanced budgets. (And this is from a finance minister, who is a member of the Social Democrats.) Many people are very bearish on the DAX and other German assets, but in an economy with strong employment, a healthy export sector, strong fiscal position and NEGATIVE interest rates, where are domestic investors going to invest?

The technicals for the DAX and the Euro STOXX look ominous while the fundamentals provide a reason to be bullish. If negative interest rates in a positive growth economy cannot sustain an equity rally, why should the FED‘s recent pivot to PAUSE provide reason for the S&Ps to rally? As to the FED‘s newfound reticence to raise rates, it seems to me that the FED suddenly realized it was racing too far ahead of the world’s other central banks so the FOMC had to recognize that while the U.S. was experiencing stronger growth, global slowing may become a headwind to American  economic forecasts. The bottom line is that the relative asset situation may favor those countries that have not experienced as robust asset appreciation as the U.S.

Lastly, as promised, here is the first episode of Futures TV Show. In the inaugural episode, Anthony Crudele and I discuss what is happening in the markets from a macro perspective and how the fundamentals are aligning with the technicals in U.S. Treasuries gold and the e-mini S&Ps. Pour yourself a glass of your favorite libation and enjoy!

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17 Responses to “Notes From Underground: A Hard Brexit Is Going To Fall?”

  1. Chicken Says:

    I suppose the question at this point is, what are the potential repercussions of an hard Brexit on Germany’s industrial complex (primarily automotive)?

    • yraharris Says:

      Chicken–it will be substantial as the German economists apprise.Also,Ambrose Pritchard had a piece on how the Italians will seeking ways to lesen the impact from a hard brexit—Italy Explores its own bilateral Brexit deal ,published yesterday.So as I try to inform this situation is very dynamic and has many moving parts.The Eur/GBP cross has been an interesting trade but difficult and kept me watching but not participating –Gilts also hold up well but the issue remains uncertain with the Eurocrats seemingly in control of the narrative promoting disaster for the UK

      • Chicken Says:

        Perhaps Wednesday evening we’ll learn more from Scholz in preparation for March end.

  2. Arthur Says:

    Exports are equivalent to almost half of Germany’s economic output.

    1. The risk of an escalating trade war between America & China (Germany’s top and third export markets respectively).
    2. Brexit (Fourth biggest export market).
    3. The restless mood in France and the unprectictable populist gov in Italy (second and sixth largest export markets).
    4. Elections European parliament (May).
    5. Bye to Angela Merkel, Draghi and Juncker.

    Germany’s Mittelstsnd are the backbone of the economy but their fate probably rises and falls with the state of the global economy.

    Is the glass half empty or half full?

    • yraharris Says:

      Arthur–well laid out–thanks.I think for PM May the glass may be 3/4 full and I responded to Chicken,the Italians are also trying to come to the aid of the UK—it biggles my mind that the twitter in chief fails to weigh in and muddy the waters even more.But as the IFO research reveals the Germans are nervous about the hard brexit outcome—and as Bill Murray would say—we got that going for us.

      • the bigman Says:

        I think another Bill Murray aphorism may be more apropos- It just doesn’t matter! The EU is done. Italy is already lining up to do a deal. Will the EU kick them out? Don’t think so Germany will soon follow suit. As has been acknowledged here many times the EU is a political wolf(Germany and France) hiding a sheep’s(common currency) clothing Well the other sheep have figured it out except for perhaps Ms May. With apologies to Chicken’s back story the sky will not fall with hard Brexit but as all here indicate tradine opportunites will abound.

      • yraharris Says:

        Bigman–you think I am a meat ball as I chase rudy the rabbit

    • David Richards Says:

      Some fundamental analysts write that point #1 will ultimately benefit Europe economically (and particularly other parts of east Asia) while hurting both US and China, like seems to have already begun.

      I’d submit the bigger fundamental factor was when the Fed shamefully flip-flopped policy and surrendered its independence & credibility by apparently acquiescing to the White House recently.

      But I prefer technicals and what stands out to me is the potential pivot happening in the US/GER 10Y Yield Spread (USGER10 on Bloomberg), looking at both the monthly over 20 years and the daily over the last 1yr. USGER10 appears to have pivoted around 280 last quarter with lots of room to the downside, unless German inflation consistently prints 200-300 pts below US inflation for the coming years (unlikely). Another amusing observation is that Bill Gross recently gave up on USGER10 and retired from Janus. It smacks of capitulation and a potential major turning point for USGER10 (and perhaps the dollar).

      IMO the path of least resistance for USGER10 is down from 280, and for EURUSD up from 1.12, at least for a EURUSD range trade if not a breakout. Some of the aforementioned east Asian currencies have already risen significantly against USD over the past few months, although DM FX hasn’t yet so they might catch up with those EM FX and rise next too.

      • yraharris Says:

        David–a really informative post and the US/GER spread ought to narrow but as I was busy interacting with readers of the FT ass the useful idiots fail to comprehend what is taking place under their noses as the repression of german savers is causing rising political opposition to the established political structure of CDU/SPD dominance.German inflation is at least 1.7% so the numbers already belie your point.Bill Gross did not heed NOTES as he went after the bright lights of ridiculously low German yields but the rewards were elsewhere–the spreads have widened out—I am always left wondering why they don’t read Rotten Heart of Europe to gain a wider perspective on the underlying problems facing the European project.The failure to put in place a eurobond backed by a harmonized taxing authority with a FDIC banking backdrop before the launch of the currency was mandatory—but the bullshit artists knew it wasn’t politically feasible—now that they built an edifice on debt and financial repression they find it may not be politically now either

      • David Richards Says:

        Yra, so true and so clear now… which leaves Euro as only a temporary, speculative trade if taken on the long side on occasion. Preferably against a currency with no yield to pay, so probably not EURUSD; maybe like EURJPY or something instead when EUR is bottom of range.

  3. Rob Syp Says:

    • yraharris Says:

      Rob–that i unbelievable.Somebody uses their mouth to bring such beauty to the world—see it can be done.Thank you for sharing it with our readers and discoursers

  4. David Richards Says:

    Regarding the US economy, which has been reporting some very weakening data and a Citi surprise index resembling Europe’s before the EU economy cratered last year, Hedgeye is forecasting that the next US GDP print will be 1.6%… If so, it’ll be an historic fall (from 4.2% midyear in 2018 from before the trade war began) and feel like a virtual US recession (actually their public outlook for US is stagflation later).

  5. David Richards Says:

    Maybe Ms May is too dumb to realize they hold some good cards? Either that or sabotage, as she was for STAY whilst some of the “victorious” LEAVE contingent have already quit in disgust or protest. If the UK gov’t eschews the decisive result of its own democratic referendum and stays after all, the GBP should rally against EUR in misguided relief temporarily, which I think would be an opportunity to fade.

    • yraharris Says:

      David–absolutely agree with that assessment —I would love to see the cross hit 78 or lower on such an outcome

    • yraharris Says:

      david –it closed the week brfore the vote at .7854 on the cross —i will enter my orders

  6. A.M. Look 2/11/19 | Says:

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