A Trigger to Revisit Bigger Global Worries

Brexit is once again shaking markets. Or is it?

By Richard Barley

Last week’s recovery in markets after the immediate shock of the Brexit vote always looked doubtful. The pound Wednesday dropped below $1.30, bond markets are going ballistic and risk appetite is taking a new drubbing. But apart from the pound, is this really about the U.K.’s exit from the European Union?

Sure, the proximate cause for the turn in markets is the news that three U.K. real-estate funds have suspended redemptions. Investors have been on alert for tangible aftershocks: now they are emerging.

Worse, they carry unfortunate echoes of the 2007 ructions in funds invested in mortgage-backed securities. That analogy shouldn’t be taken too far, however. The crisis in structured finance was far more serious as securities perceived as safe and liquid suddenly turned out to be neither, infecting the global financial system. It shouldn’t be news that property is illiquid and can be risky.

Still, the true ramifications of Brexit will take months, years, even decades to become apparent.

The process of leaving the EU will clearly be a drawn-out one. Even the near-term economic effects only will become clear later this year, although U.K. property is clearly a flashpoint that is of immediate concern. Instead, Brexit is a trigger that is exacerbating and highlighting problems that both helped cause the global financial crisis and are consequences of it.

A skyline showing the City of London financial district. U.K. property is clearly a flashpoint that is of immediate concern. Photo: Bloomberg News

The biggest of these is the search for yield and the savings glut. The precrisis version of this hunt has been amplified by central bank policy that has reduced rates to zero and pumped cash into bond markets, regulation that requires banks to hold large portfolios of liquid assets, and the persistence of low growth and inflation. One offshoot of this has been investment in illiquid assets that produce higher yields, such as real estate.

Brexit didn’t cause this, but can drive it further and make it riskier, as negative yields transform bonds from staid, income-producing assets into vehicles for speculative capital gains.

Moreover, it raises questions about the political and monetary capacity for response.

Bond markets are now moving with dazzling speed. U.S. Treasury yields have reached record lows, and the yield on Japan’s 20-year bond fell below zero for the first time ever Wednesday.

Negative yields on 10-year bonds from Germany could soon be joined by their peers from the Netherlands, Finland, Sweden and Denmark. France and Belgium aren’t far behind. The failure of bond yields to rise last week even as equities rallied was a signal that the situation is far from normal.

Investors need to remain vigilant even if they feel they are remote from the direct questions that the Brexit vote has raised about the U.K.’s economy. Yes, it is small on a global scale. But the globe was facing enough problems already.

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