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Our baseline scenario, which assumes marginally slower growth suggests no material changes to our asset allocation. We recommend some changes within the asset classes. The level of uncertainty post Brexit has increased for Europe. We keep an overall prudent stance with an underweight in equities and an overweight in credit but lift cash back to neutral. We suggest reducing euro and emerging European equities to underweight. Within fixed income we move US Treasuries to overweight but take profits as far as euro sovereign spreads and gilts are concerned following the sharp decline.
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Europe muddles through: the Brexit vote has created a large uncertainty for the UK and to some extent, albeit limited, for the rest of Europe. Our growth forecasts have been reduced by 2 percentage points (pp) for end of 2017 for the UK and 0.3 pp for Europe. We believe the Bank of England will lower rates to zero and embark on quantitative easing (QE) in H2 this year. We do not expect the European Central Bank (ECB) to do more than expanding QE by six months without changing the capital key. Meanwhile, the level shift in uncertainty should lead the US Federal Reserve (Fed) to slow down rate normalisation and not lift rates before December.
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Downside risk: political risks materialise which could test macro policy and lead to a more marked slowdown. In that scenario, the ECB would ease more substantially. The Fed would refrain from hiking rates.
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Upside risk: a swift negotiation process preserves a strong UK partnership with the EU. Risk aversion would fade rapidly. Safe haven bond yields would rise back to pre-Brexit levels and equities would stage a temporary come back.
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