(Bloomberg) — To the army of strategists, economists and investors grappling with Brexit: Relax. Take a break. Morgan Stanley (NYSE:) quants have your back.
The Wall Street bank has unleashed its computer model to map the fallout from Britain’s tortuous bid to leave the European Union, one of the most intractable issues in world finance.
The good news: The hit to assets in a no-deal exit isn’t as bad as some fear. The bad: It’s still pretty ugly, and Morgan Stanley sees a 35% chance it will happen.
Here’s what the model said about the worst-case scenario in a report published Monday:
- In equities, a no-deal Brexit will likely have a negative impact on European and U.K. stocks in the short term, but declines will be moderate (single-digit) rather than severe (double-digit). European earnings per share could drop as much as 5-6%; the has downside potential of 3-5%.
- In currencies, investors selling risk assets following a no-deal could spur a bid for the euro, a hot funding currency, cushioning its fall. The Swiss franc should rally.
- In government bonds, Morgan Stanley anticipates a widening of about 25-35 basis points in the Irish 10-year spread relative to Belgium, Austria and Finland, while the spread to Bunds could potentially rise to 100 basis points.
- German government bonds will likely take their direction from gilts, with yields for the latter possibly rising.
- In corporate bonds, the ECB’s stimulus program should cushion non-financial debt somewhat. The team sees room for greater volatility in the assets that are not directly supported by the ECB’s purchases like high yield and corporate hybrids.
To reach its conclusions, Morgan Stanley used an “input-output” framework to simulate how a change in demand in one country can be traced back through the sectors and countries that provide inputs into the final product. That allowed the firm to sketch out in fine detail a Brexit trading book.
In the process, it also helped them nab the award for understated headline of the year:
“Executive summary: Brexit is an important downside risk.”
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