The low-probability but high-impact risks mentioned by investment banks and investors include: Europe's recession, Scandinavian currency selling and emerging market crashes. Mark Dowding, chief investment officer at BlueBay Asset Management in London, said that the Halloween horror show might make the market unprepared. The outcome of the failure to reach an agreement will be extremely disruptive and the impact on the market may spread beyond Europe.
Dowding believes that the possibility of no agreement to leave the European Union before the end of this month is extremely low. After the two sides agreed to start a more detailed negotiation phase on Friday, the probability of a non-agreement to leave the EU this year fell below 15%.
However, the impact of the Brexit has been quietly spreading around the world. Due in part to political risks in Europe, including dramatic events from the UK, foreign investors have been shunning European stock markets.
Alessio de Longis, Invesco's multi-asset fund manager, said that the rules of thumb that he has been following as a global investor have basically worked in the past three years. In terms of assets, the further away from Europe and the UK, the smaller the impact.
According to Nomura International, the impact of the UK market is extremely profound: in 2018, $2 trillion of British public and private debt was held overseas. Nearly one-third of UK government bonds are held by non-local investors. Foreign claims on British banks exceed $2.3 trillion.
This does not include the possible confusion in the UK's daily $3.7 trillion interest rate derivatives market. Although the clearing department has been quarantined and many banks have contingency plans, it is difficult to completely rule out the unintended consequences of complex markets.
Jordan Rochester, foreign exchange strategist at Nomura Securities, said that the first day of Brexit may not be the worst. But after a few days or weeks, the impact began to become very obvious.
If the UK really collapses, the pound will be directly affected. Some investment banks, including Morgan Stanley, estimate that if the UK hardly retreats, the pound against the US dollar may fall by about a fifth, reaching around 1.0. The vulnerability of the pound has been fully reflected in recent trading days: the pound rose sharply last week due to the hope of reaching an agreement, but it fell sharply on Monday, because the EU said that Boris Johnson's latest proposal lacks details.
Lorenzo Bini Smaghi of Societe Generale expressed concern. At a meeting in Bloomberg last week, the chairman of the French bank described hard retreat as a “systemic event” that could push the global economy into recession.
Economists at Bank of America Merrill Lynch expect that if the agreement is not reached, the euro zone's GDP growth rate will drop by 40 basis points next year, which is worse for the already troubled euro zone.
This will have a “no agreement shock” on growth-sensitive currencies such as the Norwegian Krone and the Swedish Krona. Morgan Stanley said the euro is also at risk, but investors' demand for the euro for financing purposes may help buffer the euro's decline.
Nikolaos Panigirtzoglou, global strategist at JPMorgan Chase, believes that Europe is already on the verge of a recession. Even if a Brexit agreement is reached, there are other risks associated with the auto industry and lack of policy attractiveness. If the European economy is in a downturn, it may awaken the credit premium that has long been curbed by monetary stimulus. This will echo the breakthrough in 2016, when euro-denominated corporate bond spreads followed the spread of sterling-denominated corporate bonds.
There may be a ripple effect in the private debt and alternative asset markets that are difficult to trade, and funds that invest heavily in such assets may hold assets that cannot be converted.
At the same time, Bank of America Merrill Lynch believes that in the stock market, if the deal is not reached, the European stock market may fall by 8%.