This morning’s stunning news that UK citizens have voted to leave the European Union is sending shock waves through global financial markets. Equities around the world are cratering today, having anticipated a more benign outcome to the vote earlier in the week. Investors are fleeing from the British pound, the euro, and global equities in favor of the perceived safe havens of US Treasuries, German bunds, and the Japanese yen.
While longer-term impacts of this historic vote are quite unclear at present, one likely outcome is that this action will inject a new level of uncertainty into the global economic outlook, resulting in heightened volatility in financial markets and near-term pressure on economies heavily dependent on global trade.
In the midst of today’s financial market weakness, it is important to keep in mind the following points:
- It will be several years before the UK actually exits from the EU, if at all. The new Prime Minister that will replace David Cameron later this year has the power to invoke Article 50, which starts a 2-year clock on negotiations between the UK and the EU. Between now and then, the British government may find a way to appease Brexit supporters without a full-blown exit. Uncertainty will reign.
- The most direct effects will be felt in the UK, Europe, and other large trading partners such as China. Economists are predicting a significant hit to UK and EU growth in coming years with GDP forecasts being shaved by as much as 2 percentage points in both entities. Emerging market countries that depend on exports to the EU will also be negatively impacted. Despite its large size, the US is relatively well insulated from the turmoil, since less than 15% of our GDP is derived from trade with other countries.
- A sustained rise in the US dollar may be the most negative outcome of the Brexit vote for the US economy. If the dollar continues to appreciate from safe haven flows out of the British pound and the euro, it will provide an additional headwind to US multinationals doing business overseas. In addition, emerging market companies that have borrowed heavily in dollars will find it more difficult to repay those debts with their less-valuable currencies.
- The Brexit vote may clear the way for other EU countries to consider a similar path. Down the road, a complete dissolution of the EU is not out of the question. On the other hand, the economic disruption caused by the UK’s exit may reinforce the value of a common currency, easy mobility among member countries, and low trade barriers.
- Further downward pressure on interest rates is likely. Actions by the European Central Bank (ECB) to provide liquidity to financial markets are likely to send European interest rates even further into negative territory. With more than $10 trillion of European bonds already trading with negative yields, the impacts of these additional efforts are quite uncertain. US yields are likely to also follow a lower path in the near-term, although we don’t anticipate negative yields on US bonds.
- The risks of a global financial crisis a la 2008 are unlikely, in our view. Global central banks have had plenty of time to prepare for this outcome, and have many tools at their disposal to provide liquidity to nervous funding markets. As a result of new regulations and heightened scrutiny, banks have dramatically increased their capital levels since the last crisis. And finally, a sharp decline in the pound and euro versus the dollar should improve their competitive standing and cushion the economic consequences of Brexit.
Today’s vote is likely to increase the political power of those parties favoring more economic protectionism and anti-immigration policies. The impact of that outcome is likely a negative from an economic standpoint. How significant this trend becomes remains to be seen.
It is rarely a sound investment strategy to sell into a market in panic mode like the one we are experiencing today. As we write this, markets are recovering from the initial downdraft after the news of the vote became known. We would not be chasing the rally in safe-haven US treasury bonds.
A better question might be whether this selloff represents a legitimate buying opportunity for those investors with a longer term time horizon. While our tendency would normally be to take advantage of this decline, the degree of economic uncertainty surrounding the news causes us to be more cautious until the outlook becomes a bit clearer. In the meantime, opportunities to recognize losses and reinvest in similar securities will provide our clients with tax benefits they can utilize in the future.
Managing Director & Director of Portfolio Research
The discussions and opinions in this market summary are for general information only, and are not intended to provide investment advice. While taken from sources deemed to be accurate, Ballentine Partners makes no representations about the accuracy of the information in the market summary or its appropriateness for any given situation. Past performance of the indices shown is not necessarily indicative of future results.