Boris Johnson has just announced that he will campaign for an out vote in the coming British referendum on European Union membership. Sterling promptly dropped more than it has in any one day for 11 months. This is a sign of what the UK financial markets are going to be like for the next four months. Highly volatile as the likelihood of Brexit flows one way and the other. Some UK markets will however be more volatile than others.
The economic background here is that the efficient markets hypothesis says that new information will be swiftly, efficiently, incorporated into market prices. It absolutely is not saying that markets are the efficient way of doing everything, only that the processing of new information is something that is done efficiently by markets. As here with Boris. His opting for the out side makes out a more likely outcome than it was before. We also didn't know which way he would jump (his calculation was about what is best for the career of B. Johnson, little else). So, we've new information and a near immediate reaction in market prices. That EMH is looking pretty good so far.
The general thought is that if Brexit does happen then sterling will fall relative to both the US $ and the €. I'm hugely biased here and think that in the medium term it will be entirely beneficial to the UK economy if Brexit does happen: but perfectly willing to agree that the short term effect would be for sterling to fall as uncertainty persists about exactly how Brexit will work.
For investors this is going to make the British markets difficult over the next four months as the referendum approaches. Sterling's volatility is going to be driven by the perceptions (and the opinion polls) of who is winning, in or out. Fundamentals aren't going to be what drives prices, political emotions are. Of course that means one can have fun placing bets but they will be that, bets, not informed investment decisions.
As AXA, writing in the FT out it:
But the only thing that is certain is that idiosyncratic market volatility will remain high in the UK until after the summer.
Volatility is not going to be equal though. Sterling is going to bounce around on those views of in or out. And we might expect the other markets to do the same: but that isn't going to be quite so. The FTSE100 for example will be much more stable than sterling. Largely on the grounds that the FTSE100 has very little to do with the UK domestic economy. At least 70% of the gross revenue of those firms within the index comes from outside the UK, outside the sterling area or economy.
FTSE 250, the next group of smaller listed companies downwards is much more associated with the domestic UK economy. So that index will be more volatile than the 100, but less so than sterling. The credit markets, both bonds and interest rates themselves, should have the least volatility of all. The UK is already outside the eurozone, still controls its own monetary policy, so EU exit won't affect those. It will only be the derivative effects of whatever other changes take place in the economy that matter.
The EMH does, as above, only insist that new information is swiftly incorporated into prices. Thus when we've uncertainty about the future we must expect prices to be volatile. For each new piece of information is going to change views of what that future is to be. Thus, in the run up to this Brexit referendum we must expect UK financial prices to be volatile as information about whether in or out is winning flows across the system.
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