Brexit – What Happens Next and How It Impacts Institutional Cash Investors

Abstract

We leave our readers managing intuitional cash portfolios with the following takeaways:

1. Brexit will likely have a major impact on the UK, politically, economically and financially. It is less so on the EU and the US. Look for short-term volatility and maintain sufficient liquidity as market liquidity may be less predictable than before.
2. Expect more accommodating central bank policies. With BoE and ECB likely cutting rates and expanding asset purchase programs, yields on high quality liquid assets will remain low for months ahead. Expect the Fed to slow down its interest rate normalization process, possibly putting hikes on hold until the second half of 2017.
3. With low yield comes the tendency to reach for lower credit quality instruments. Beware of credit risk as the recent wave of mergers & acquisitions and share buybacks have dampened corporate credit strength and increased financial leverage.
4. Brexit came at an inopportune time as US prime money market reform is set to take effect in October. This may encourage more flight-to-quality induced asset outflows from prime funds into other instruments.
5. The drop in short-term government yields and steepening of the credit yield curve creates opportunities for separately managed account investors to own high-quality liquid credit instruments further out on the yield curve for attractive return potential.

Introduction

“May you live in interesting times” is an often-cited British expression of unknown Chinese origin. On June 24, 2016, the British people woke up to a seismic outcome of historic significance – the nation voted to leave the European Union (EU) after 43 years with a margin of 51.9% to 48.1%.
The unanticipated nature of the outcome caught citizens, policymakers, and global markets by surprise. With mounting uncertainties and volatile market trading, the inevitable questions for market participants are: What does this mean to us? What happens next? How do I prepare for the fallout of the UK’s separation from the EU, colloquially known as Brexit?
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