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Brexit Invokes Japanese Fiscal Stimulus Plans – Is Europe Next?

Over the past few weeks we said the decision by the UK to leave the European Union could actually end up being a net positive for the global economic recovery.

Why?  Because it could finally invoke some much needed global fiscal stimulus – a piece of the policy puzzle that has been missing.  As central banks have been manufacturing a recovery from one of the worst global economic crises in history, they’ve had no help from the politicians on the fiscal side.  Governments have been unwilling to combat the fallout from a debt crisis with more debt.  It’s has been politically unpalatable.  In fact, most have been belt tightening. For Europe, the strategy sent them back into recession and into another fight with deflationary pressures.

But on cue (following Brexit), Japan has now announced they will be rolling out a “big, bold” spending package, after Abe’s party secured a super majority in the upper house over the weekend.  The package is said to be about $200 billion dollars in fiscal stimulus this year. That’s about 4% of GDP.

As we’ve said, if we look back through history, the meaningful turning points in markets have been triggered by intervention.  We’ve seen plenty examples in the bottoms made along the path of the recovery in stocks from the 2009 lows (including the coordinated central bank intervention that put in the ultimate bottom in the post-Lehman stock market crash).

Today, Japanese stocks have jumped 4% on the news.  The yen has done an about face against the dollar, weakening by more than 2%.  And U.S. stocks have broken out to new record highs.

So what’s lagging or not following the message being sent by U.S. stocks?  Japanese and German stocks had been the laggards going into the end of last week.  Both are perhaps beginning the road of catch-up today.

But yields remain the big disconnected market.

German yields touched near record lows this morning, before finishing higher (record low was -20 basis points on the 10-year German bund).  And U.S. 10-year yields, which traded as low as 1.32% last week, are moving higher, following the broader positive sentiment of the day.

With that, as we’ve said, we think Europe has an excuse to greenlight fiscal stimulus for constituent EU countries as well.  With contagion remaining the big risk associated with Brexit, government spending packages in Europe can be the relief valve for all of the pressure of rising nationalist movements in Europe and overall discontent that underpins the ‘leave’ spillover risk.
The Japanese news might be a good kick starter for cementing the bottom on this Brexit influence on global markets, but it may take Europe to follow their lead, with fiscal stimulus, before the storm is fully passed.

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Bryan: