Brexit is potentially the biggest geopolitical risk of 2016 (see our previous Brexit commentary on goodreturns.co.nz here). With voting day just 13 days away, market volatility is picking up.
The following graph shows US investor sentiment towards Europe. The dark blue line (left axis) tracks flows from US investors into European funds. From a US$4b high in early 2015, the inflows have turned into outflows to the tune of US$3b. This suggests US investors are increasingly worried that the UK will leave the EU.
The light blue line (right axis, inverted) represents the UK Policy Uncertainty index. This tracks the frequency of keywords (“monetary” “fiscal”, “uncertain”, “economy” etc) in newspaper articles, providing insight into how market commentators perceive economic uncertainty. The announcement of a referendum in February 2015 saw a short spike in the Policy Uncertainty index. This was trumped in late 2015, as both the “Bremain” and “Brexit” camps ramped up their efforts. From late 2015 the Policy Uncertainty index has risen consistently and now sits at an all-time high. This rapid increase in uncertainty could be a key reason why US investors are withdrawing from European funds.
Current voting suggests that the leave campaign is edging ahead - 5 of the last 8 polls have “leave” leading (Source: The Economist). This has been supported by the British Pound volatility index (BPVIX), which has shot up from a stable 8 index points at the start of the year to 24 (see graph below). A successful Brexit vote would likely see a rapid depreciation of Sterling, with some commentators suggesting it could be upwards of 10%. The next couple of weeks (and possibly months) could be bumpy for UK equities and Sterling…..
by Karl Geal-Otter (Pathfinder Analyst)