Post-Brexit Dominoes Begin to Fall. So Does Pound.

Post-Brexit Dominoes Begin to Fall. So Does Pound.

The first major post-Brexit domino fell as three of the UK's largest real-estate funds had to freeze $12 billion of assets that investors tried to withdraw. They simply don't have that much cash to repay them. £9.1 billion 

London at night
London at night iStock

12 billion dollars is 9.1 billion pounds sterling, but by the time you read this, the pound may be even weaker. The British currency is at its lowest against the euro since 2013 and its lowest versus the US dollar since 1985. It sank on Tuesday below the lowest price reached after the Brexit vote. There are is no obvious reason, technical or fundamental, not to expect it to fall further, but for shorter-term traders, the volatility means plenty of opportunities in both directions. 

That word, "volatility," has come to be a more central measuring tool than it had been, both for economic analysts and for traders in (virtual) pits. For example, analysts trying to predict or guess at whether the stock markets have reached their post-Brexit lows are using the CBOE Volatility Index® (VIX®) as a measure. 

After the "crash" of August 2015, which less dramatic folks call a correction or dip, the VIX spiked almost to 40. While volatility doesn't by definition mean a strong move in one direction, in practical terms, it is the big moves up or down—especially down—that result in the biggest jumps in the VIX. 

Right now the VIX is trading in the low- to mid-teens, not especially volatile considering what is happening to the UK currency and considering the overall uncertainty in British manufacturing and, in today's case, investment funds based on real estate. 

Real estate is obviously not as fungible or liquid an asset as others. You can't quickly convert it into another form of capital and then back again. To make a crude comparison, you can have a yen-Aussie dollar carry trade in which you interconvert the two currencies back and forth in a few hours, to profit from the differences in their exchange value relative to the US dollar or other currencies. There is no house-to-cash-and-back-to-house-again carry trade. Even using real estate as collateral for a loan is a slower and more involved process. 

Beyond that is the way in which real estate is valued. It's valued by its location and by the value of the neighboring properties. A tiny flat in Tokyo or Mumbai is worth more than a mansion in Michigan for this reason. And for the same reason, office space in London is not what it was a few months ago. 

Specifically, it isn't office space in the financial center of Europe. Technically, it isn't even in Europe anymore, at least not from an investor's point of view. Green Street Advisors LLC, a London-based real estate research company, says that demand for offices in London will slow "dramatically" and that property values could drop 20 percent in the first three years after the UK formally leaves the EU. 

In short, companies will leave, not many others will take their place, and the British economy will stagnate. Bloomberg surveyed economists and found nearly three-fourths of them predict that the UK will go into recession. Construction in the UK has shrunk at the fastest pace since 2009. 

What makes the shakiness of the UK real estate market and real estate funds even more unsettling is the memory of what triggered the Great Recession in 2007. It was a collapse in real estate which no one expected. 

Perhaps with that in mind, Bank of England Governor Mark Carney on Tuesday published its bi-annual Financial Stability Report with a detailed outline of measures that it could and would take to offset any recessionary developments. At the same time, Carney was candid during the press conference announcing the report, saying that his worries about the possible negative effects of Brexit were coming true. 

Carney now faces a test of what monetary policy can do to keep an economy from sliding into recession, especially when fiscal policy is in the hands of an unsteady and directionless government. As the Tories face the departure of Cameron, the withdrawal of Boris Johnson, and the infighting among the remaining contenders, it would seem an opportune moment for Labour to swoop in with a return to Blairism. 

Instead, Labour is in the midst of its own civil war, leaving both British citizens and onlookers wondering who exactly might lead. Nonetheless, the FTSE was up today while US stocks were down. The only things traders can say for sure is that each day brings strongly trending markets in both directions. If you are managing risk carefully or trading Nadex, where limited risk is guaranteed and built into the trade, you can profit from those short-term trends. 

In the long-term, however, the effects of what is looking more and more like a needless, self-inflicted wounding are a story that's going to be with us for years to come. Unless, of course, what's left of the UK government heeds the millions who are petitioning for a second referendum. Their case is looking stronger by the day and a second referendum seems, if nothing else, at least as sensible as the first.  

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