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Investors should brace for more post-Brexit volatility, says El-Erian

Mohamed El-Erian

NEW YORK -- World markets are facing difficulties due to the outcome of the British referendum, known as Brexit, to leave the European Union. Investors are living in an unusual uncertain world, says economist Mohamed El-Erian.

The stunning outcome of the Brexit vote is likely to shave at least 0.5 percentage points of growth, and make both the U.K. and the EU more vulnerable to a recession, Allianz's chief economic adviser told The Nikkei. El-Erian served as CEO of U.S. bond firm Pimco until March 2014 and popularized the term "the new normal" in reference to persistent sluggish growth following the 2008 financial crisis.

Q: How do you see the outcome of the referendum? What caused this situation?

A: The outcome of the Brexit referendum was yet another sign of the extent to which notable segments of the population in Europe and the U.S. have lost trust in the political and business elites, as well as in "expert opinion." It also illustrates how a single emotional issue, in this case immigration, can overwhelm a rational analysis of the multiple factors that warrant proper consideration in the face of such an important vote.

Q: Global markets are unstable because of the result. How long will this last?

A: Think of it as a tug-of-war between the shock effect and the deployment of cash on the sidelines. The initial reaction will be a selloff as traders respond to the surprise of a likely Brexit that would add structural uncertainty to global economic fragility and financial fluidity. The lower market prices would then attract buying interest from the considerable investible cash that is on the sidelines.

Q: How should authorities around the world react to these issues? What kind of measures will be necessary?

A: What is needed is a comprehensive policy response that promotes high and more inclusive growth, including a reduction in the inequality of income, wealth and opportunity. The good news is that engineering for this is known. Unfortunately, the political environment is not conducive to sustained and full implementation. As such, the world is likely continue to over-rely on central banks, whose stretched and near-exhausted tools are ill-equipped for the task at hand.

Q: Will it be inevitable for the U.K. and EU to fall into lower growth?

A: I am afraid so as the proper policy response is likely to be undermined by political polarization. Specifically, the stunning outcome of the Brexit vote is likely to shave at least 0.5 percentage points of growth, and make both more vulnerable to a recession.

Q: Will it affect U.S economy and the Federal Reserve's rate hike policy? How many times will the Fed raise rate this year?

A: With yet another external headwind facing the U.S. economy, the Brexit vote is likely to delay a Fed rate hike. In all, I expect we will get one hike this year.

Q: How will emerging countries be affected?

A: Much depends on how long it takes for financial markets to recover fully. If the recovery is quick -- and the first few days have been encouraging in this regard -- than the impact on emerging economies will be limited.

Q: Will the uncertainty in China increase due to its close relationship with the U.K.?

A: For China, the short-term disruptions from lower growth will come with significant economic and financial opportunities longer-term. Over time, and if Brexit proceeds, China will likely become a bigger trading partner for the U.K. and a larger investor.

Q: Do you think this is the beginning of an anti-globalization trend? Will this outcome drive populism around the world?

A: It will slow the type of globalization that is non-inclusive. As such, for example, the emphasis on free trade will include an important notion of fair trade. Trade agreements will be harder to conclude. And governments will be pressured to pay greater attention to compositional aspects.

The impact on populism in other parts of Europe and the rest of the world is two-fold. In the first instance, the Brexit referendum will embolden anti-establishment and fringe parties. But there will also be an opposite effect as people observe the "buyer's remorse" that will prevail in the U.K. The exact balance between these two factors will vary from country to country.

Q: How should investors brace for this unexpected and unprecedented situation? Should they be prepared for the next turmoil?

A: The referendum serves as a reminder to investors that we are living in an "unusually uncertain" world, and that central banks cannot shield financial markets forever from the sustained impact of economic, financial and political fluidity. To navigate such a world, investors need to brace for more frequent bouts of market volatility, add a tactical component to their strategic investment approach, realize that they cannot rely just on asset diversification as their only risk mitigation strategy, and be willing to hold a larger cash cushion in their strategic asset allocations.

Interviewed by Nikkei staff writer Akira Yamashita

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