Brexit: How Extreme are Market Levels?

As we start the first full trading week after the UK’s historic vote to leave the European Union, it’s useful to put today’s market levels, and Friday’s moves, into context.

In the run up to the vote, market expectations moved to an 80% implied probability of Remain winning – something that saw the British pound rise to a level of 1.50 to the dollar after polls closed on Thursday night. As events unfolded and the implied probability of Remain fell from 80% to 0%, large gyrations across most financial markets were not surprising. Most notably, the pound traded in a 12% range against the US dollar.

Looking back further, we can see that even after Friday’s swings, current market levels are comparable to where they have been in the run up to Thursday’s vote. The table below shows today’s opening levels, where we were last Monday and how these compare to the most extreme levels seen in the three weeks prior to the referendum. The striking thing about such a comparison is how many major markets have already been at or near today’s levels.

Of course that does not mean that markets will hold these levels, and there will no doubt be bouts of volatility in the days and weeks ahead. So far the largest moves have been in UK related assets: the British pound, UK gilts and UK bank stocks. US treasuries have also rallied, benefitting from a flight to quality. If this pattern holds, it is consistent with the tightening in financial conditions being most pronounced in the UK with a much less extreme tightening at the global level. How markets move over the next days and weeks will give us more clarity on this, with market moves outside of UK assets key. But at least today market reaction suggests that Brexit could be more a local rather than globally systemic event.

Political news to date also supports the view that Brexit risk can be contained to the UK economy. News over the weekend suggests that there will be no knee-jerk exit, with negotiations likely to start in the autumn once the ruling Conservative party has chosen its new leader. However, with the opposition Labour party having internal problems of its own, and the Scottish Nationalist Party making it quite clear that they would oppose any move to leave the free trade area, it is clear that negotiating the exit will not be straightforward. Overall, while initial market moves suggest that the fall-out from the Brexit vote can be contained, considerable uncertainty still looms.