Despite a majority voting in favour of Brexit in the referendum, UBP's chief economist Patrice Gautry is ruling out a global recession. Although the market uncertainty arising from the referendum result could prove costly, its impact will be more political than economic. "We are ruling out a global recession, and we are currently expecting the world economy to grow by around 3%. So global growth will be moderate, but real nonetheless given the low-inflation background," explained Mr Gautry. In his central scenario, global demand is the factor most likely to weaken. In a context of weak growth and weak demand, the Fed will probably be forced to delay rate hikes even longer.
Europe and eurozone: impact more political than economic
"Similarly, the European Central Bank's monetary policy will remain loose because inflation will stay low in Europe and there is still surplus capacity in manufacturing," according to Mr Gautry. As a result, UBP has reduced its eurozone growth forecasts to 1.4% for 2016 and 1.3% for 2017. "We have adjusted our central scenario to include weaker growth and a weaker euro, along with a higher risk premium on European investments because of greater political uncertainty in Europe," he continued.
So UBP is not expecting any big bang in Europe, either in economic or political terms, but rather risks of a political fragmentation of the European Union, with the possibility of increasing numbers of countries and regions either demanding to leave the EU or to have a special status within it. In Patrice Gautry's view, these political discussions will inevitably affect the ECB's actions.
Recession ahead in the UK?
Mr Gautry believes that only the UK shows a risk of recession, not Europe as a whole.
Regarding the UK, Patrice Gautry said that "on the economic front, we are not ruling out short-term shocks to consumer confidence, jobs or decisions regarding capital expenditure and foreign direct investment". He expects UK growth to take a hit. He has cut his forecast to 1.4% in 2016 as opposed to the 2.3% seen in 2015, and he sees a high probability of a recession in 2017, with GDP likely to fall 1%, although visibility is very low on that timeframe. The fall in sterling means that UK inflation is expected to rise from 0% to 2%, and significantly above 2% in 2017.
"With growth weakening and possibly turning negative, and with inflation rising, the Bank of England could cut its base rate from 0.50% to 0% and expand quantitative easing," said Mr Gautry.
Once article 50 of the Treaty on European Union is triggered, the exit process will take time, with negotiations taking at least two years. "The uncertainty and lack of visibility in the markets will obviously be increased by the unavoidably lengthy nature of the process and the numerous matters that will arise during negotiations, including free trade, free movement of capital and passporting for financial services companies," according to Patrice Gautry. "As a result, we have adopted an extremely cautious scenario, expecting the UK economy to shrink by 1% in 2017."
Pan-European equities: a return to defensive stocks
The pro-Brexit referendum result has prompted UBP's European equities team to adjust its central equities scenario. "We have decided to reduce our exposure to financial stocks, particularly banks, as well as our exposure to domestic cyclical sectors such as consumer discretionary," said Rob Jones and Scott Meech, co-heads of European equities. "Meanwhile, we have increased our portfolios' exposure to the consumer staples, healthcare and oil sectors, because of their defensive qualities."
However, the Fed is very likely to delay any rate hikes, which is good news for equities as a whole, and means that Rob Jones and Scott Meech remain confident about capital expenditure. "Based on our discussions with companies, they believe that the Brexit vote will have “have little impact on corporate behaviour in the immediate future”.," they added.
Before the referendum, valuations were low and therefore attractive for certain stocks with good prospects. As a result, there are still good opportunities for international investors wanting to initiate or add to positions in equity markets across Europe
Senior Portfolio Manager
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Attractive buying levels for credit in Europe
The fixed-income scenario has not fundamentally changed following the referendum result. "Although the outcome was unexpected, markets traded in an orderly fashion," according to Christel Rendu de Lint, head of fixed income. "At the moment, we need to distinguish clearly between what could be seen as the start of a global recession (which we do not expect to happen) and a bias towards moving into assets seen as less risky, such as sovereign bonds."
The market correction that followed the Brexit vote created attractive buying levels for credit bonds, especially since the probability of default has not increased significantly in the asset class. Although volatility will remain elevated, causing a slight increase in risk premiums, no major adverse developments are expected in the credit market unless other long-standing EU member-states also start talking about exit referendums. UBP's central strategy and favoured sectors have not changed significantly since the referendum: "we are continuing to identify the positive medium- to long-term fundamentals of each investment, and we are looking for attractive carry and risk/return profiles that will enable us to maintain maximum liquidity while actively managing risk," said Christel Rendu de Lint.
Christel Rendu de Lint
Head of Fixed Income
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