Quantitative Easing now seems to be unavoidable after a Brexit

by Secular Investor

You have probably already read dozens of articles and op-ed’s about the Brexit vote and its impact on the political landscape in Europe. The markets completely crashed ‘the day after’ but quickly regained their composure and the losses of 5-8% at the opening bell were quickly erased.

Source: Stockcharts.com

Now, just one week later, most indices are trading at higher levels than right before the Brexit, and everything seems to be forgiven and forgotten, especially as nor David Cameron nor the potential future prime minister seem to be keen to trigger the now-famous Article 50 in the European Treaty. This means it’s very unlikely a ‘Brexit’ will be completed before the end of this decade.
And that’s exactly what financial markets used to hate; the simple fact there’s absolutely no visibility about how the European block will look like just one or three years from now will definitely have a negative impact, and that’s also exactly what the IMF has been warning for. IMF-boss Lagarde called the potential Brexit (it’s still just a chance, nothing has been effectively decided yet) an ‘immediate threat to the world economy’ and ‘putting the UK on the brink of a recession’. (yes, she did use the R-word)
She also warned the recovery from the Global Financial Crisis is going way too slow and is too fragile’, and whereas this sort of message would be seen as bad news in any world dominated by common sense, the markets quickly became optimistic again, as the rate hikes will now be completely off the table whilst another round of Quantitative Easing is back on that same table.
In a relatively long working paper, released by the Bank of England, Mark Carney tries to soften the blow by explaining how well-capitalized the British Banks are, as the capital requirements are now ten times as strict compared to before the financial crisis in 2008.

Source: Bank of England
However, the uncertainty regarding the economic policy in the UK hasn’t been this high in the past two decades. Even during the Global Financial Crisis and Euro-crises the uncertainty was lower than what we’re seeing now, as you can see on the previous image.  The uncertainty will cause consumers to start hoarding more cash instead of deploying it in the market. Again from the Bank of England:

‘As a result of increased uncertainty and tighter financial conditions, UK households could defer consumption and firms delay investment, lowering labour demand and causing unemployment to rise. Through financial market and confidence channels, there are also risks of adverse spillovers to the global economy. Over the coming weeks, the Bank will consider a host of other measures and policies to promote monetary and financial stability.’

Source: Stockcharts.com
Reading between the lines, you can expect the Bank of England starting a substantial program of Quantitative Easing to calm the rattled markets, and that’s the main (and probably only) reason why the main indices are currently trading higher (the FTSE 100 is trading almost 3% higher than before the surprising leave-vote) than right before the Brexit. The yield on the 10-year UK Gilt’s and even the 10 year rate on the US treasuries have reached decade-lows, indicating the market is expecting the interest rates to go down, rather than to go up.