Fear and safety will dominate

Fear and safety will dominate

by Doug Drabik, Fixed Income, Raymond James

According to Google, after the vote was complete, the 2nd most asked question by the people of the U.K. was “What is the EU?” Closely behind was “Which countries are in the EU?” The number one question wasn’t much better: “What does it mean to leave the EU?”

I guess it’s implied that at least some of the voters had no idea what they were voting on or the implications of this vote. But let’s give the majority of the people the benefit of the doubt. Clearly they knew that this change would have consequences. Perhaps the British vote to exit reflects a belief that the benefits of independence from the European Union (EU) will outweigh any financial consequences. The vote to leave an undesired regulated state should resonate vociferously with us Americans.

The financial markets got it wrong. All pre-trading vote was lining up as if the vote would be to remain in the EU. It is not unlike the markets to overreact and it is important to see how this settles after a couple of weeks. Volatility is a reflection of doubt, insecurity or unsettled commitment to direction. Certainly we will continue to see volatility as long as uncertainty persists.

The bigger question may be how this vote will affect the remaining members of the EU and to a lesser extent, how it will affect the U.K. The British have laid their path. Initial reaction reflects the British pound weakening to recent new lows and the ripple effects of a flight to quality being felt by global interests, especially the U.S.; however, what is still to play out are the consequences to the EU. Will this start a change reaction of other member countries wishing to part ways? What effect will this have on Germany supporting the weaker countries of the EU? Remember that the U.K. was the 2nd largest GDP producing member and the 5th largest GDP nation in the world.

What has been puzzling and is being amplified by this global event are interest rates and related risks. Where would you feel safer holding your money? The U.K.? Germany? Italy? Japan? Judged strictly by reward (yield), the perceived safety (credit) of these countries surpasses that of the U.S.:

Knowing the U.S. is perhaps the most stable of the economic powers, it is highly possible we continue to see our yields retract towards global interest rates as mediocre to low rates still trump even lower to negative interest rates. Fear and safety of principal should be expected to dominate as money floods the U.S. bond market.

Copyright © Raymond James