Brexit fallout: Threat for equities is more from currency swings

Santosh Nairmoneycontrol.comIn theory, political crises like Brexit cannot be resolved with monetary tools like rate cuts and liquidity infusion by central banks. And yet a monetary response appears inevitable as financial markets react to the fallout of Brexit in the coming days. There has not been any liquidity shocks so far, but the growing view is that currency and bond markets are likely to be volatile in the short-term.Liquidity infusion by central banks will be music to the ears of emerging markets. “Brexit provides an excuse for more monetary easing by the G7 central banks including, sooner or later, the Federal Reserve,” writes CLSA analyst Chris Wood, raising outlook on emerging markets to ‘overweight’ from neutral.Even if there are no overt measures, at the very least, market experts are not expecting a rate hike by the US Federal Reserve in the foreseeable future. Back home, a section of market players are counting on a dovish RBI Governor to replace Raghuram Rajan in a couple of months of now. If both situations play out as expected, it means liquidity will be the least of worries for bulls in the Indian stock market.Will easy money be the answer to the Brexit problem? Already there is growing skepticism about how lower can interest rates go.And the Bank of International Settlements—a vocal critic of ultra low interest rates—has cautioned that central banks should not react strongly to Brexit, but should instead focus on restoring normalcy in interest rates and fixing the debt problems of Europe. BIS has been long arguing against too much easing by central banks, saying it did nothing but inflate asset prices without really stimulating economic growth. BIS’s warnings, as well as the occasional alarm bells sounded by the IMF and World Bank on this issue have gone unheeded so far. There is little reason to believe that things will change anytime soon.A couple of days ago, RBI Governor Raghuram Rajan had said that some volatility in the currency market was inevitable, because of the sharp move in the pound sterling. And while some bit of intervention by the authorities was warranted, Rajan has cautioned central banks from using Brexit as an excuse to devalue their respective currencies to gain a competitive advantage in trade.Easy money may spell good news for emerging markets in the short term, but it could also have side effects emanating from volatile exchange rates.