November 30, 2016    3 minute read

Beware The Frexit

Eurozone Unrest    November 30, 2016    3 minute read

Beware The Frexit

Outlooks are an educated flip of a coin. No one can say with certainty what is going to happen, but nevertheless, one can always give it a go.

What is certain is that many future growth projections get revised down as the year in question gets closer and closer. For instance, in 2011, the global GDP forecast for 2014 was up to near 5%. Every quarter thereafter this forecast was revised down to the point where six months before 2014, the expected growth rate was 3.5%.

The Odd Duck Year

Given that, global growth according to the IMF is expected to be slightly higher at 3.4% for 2017 relative to the 3.1% in 2016. The usual suspects are to blame for this very slight increase, namely a sluggish Eurozone, a low flying Japanese economy, as well as the obvious uncertainties from Brexit. However, everyone knows, life is often never as good as it seems and in many respects, more importantly, never as bad as it first appears.

From a European perspective, whether the ECB continues to extend its stimulus program in Q2 of next year is irrelevant. The Eurozone is a bank-based system so buying corporate bonds, or even lesser grade debt will not have any impact, much like German bund returns. The hype around the Italian election is overdone. If the Italian people were given a choice to remain or leave the EU, they would, of course, opt to remain. They have far more to lose than the UK.

The French Weighing In

What is crucial to the EU project is the view of the French. The concept of a unified Europe was created to prevent another World War. It was not designed to be the next best economic and financial centre. That said, it will not be dissolving anytime soon unless Marine Le Pen gets the opportunity to give the French people the option to leave the EU. Her view and the French population’s may differ, but immigration is her major selling point, much like the Brexit camp’s headline. A Frexit seems unthinkable, much like Britain leaving the EU did.

3.4% is the expected growth of
the global economy in 2017

If the global landscape has taught one anything, it is to expect the unexpected. If France did indeed decide to leave, the repercussions would be slightly larger than a Greek exit. The core of the Euro system would be shaken. It would be a matter of days before the inevitable downgrades of French debt along with those of many of the peripheral European nations.

Spreads over bunds would rocket and ironically, Britain may become a safe haven despite its whopping reliance of foreign funding to plug the ever-deepening black hole.

What Would The Germans Do?

In this scenario, would the Germans continue to support the European project as they have done repeatedly, despite calls from some to give Greece the boot? It would be a question of solidarity over solidity, with solidarity likely to trump. If Merkel gave the German people a referendum on EU membership and given the massive creditor position they find themselves in, not to mention they have benefited hugely from a weaker currency over the decades, can one really see them voting to abandon ship?

To use a Monty Python phrase from the scene where his arm had been cut off: ‘tis but a scratch’.

If that all sounds depressing, at least the stock market will rally due to more QE.

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