Senior Investment Consultant
Bridgebay Financial, Inc.
The impact of the Brexit vote on June 23, 2016 is expected to lead to
weaker global growth and apply pressure on Central Banks to keep interest rates
low for longer than had previously been anticipated.
Although global stocks regained some of the losses following the Brexit
results, the markets will continue to be volatile with periodic flights to
quality and safety. The US stock and
bond markets are seen as safe-haven assets and should be the beneficiaries of
more international uncertainty. On July
5th the flight to safe haven assets intensified with foreign investors pouring
money into US fixed income markets. High
yield bonds saw massive inflows. The
10-year treasury yield fell to 1.37%.
There will be continued economic, political and geopolitical
uncertainty that will create heightened volatility. Increased political uncertainty combined with
moderate to slow global growth and continued accommodative central bank low
rate policies will keep markets nervous.
The EU could try to discourage other countries from leaving the
economic union by punishing the UK capital markets that currently benefit as a
gateway to the EU.
The UK leads Europe in capital markets and other financial services. As
much as 85% of hedge fund assets, 78% FX trading, 74% interest rate OTC
derivatives trading, 64% private equity and 50% of all European fund management
goes through London.
The UK vote to leave the European Union (EU) has started a long period
of political, economic and market uncertainty for both the UK and EU. Markets will continue to have increased
volatility with periodic sell-offs in stocks and other global risk assets as
the Brexit process evolves. The EU is
also threatened from within by populist groups that may also want to leave the
EU, though the Spanish elections following the Brexit vote retained the current
Rajoy government that favors remaining in the EU. Italy has a referendum vote in October.
Political Turmoil
UK Prime Minister David Cameron, who favored Remain in the EU, will
resign by October, 2016. Already the
Conservative Party is having other leadership issues as well as the head of the
Independent Party’s resignation.
Essentially, the UK is experiencing considerable political infighting
and turmoil. Ironically the referendum
is considered non-binding but no leader has the political will at this time to
challenge it. This may be an opening for
the next prime minister.
Additionally, Scotland may call for another independence referendum to
leave the UK in order to remain in the EU.
Northern Ireland had also voted to Remain and they too may seek to leave
the UK in favor of remaining in the EU.
The UK exit is expected to be complicated as decades of negotiations
and trade agreements are laboriously unwound.
Per the Treaty on European Union Article 50, the UK will have 2 years
from the date the UK officially notifies the European Commission (EC) of its
intention to leave the EU
To complete its exit. The
earliest departure would be June, 2018.
Any potential savings from leaving the EU are expected to be overrun
with losses in services, new investment flows and exports resulting in a net
loss to the UK economy. The Brexit will
most likely lower UK growth and investment and potentially lead to higher UK
unemployment and inflation.
The EU loses a global financial center with strong access to world
markets. Many banks have already
indicated that they may re-locate operations from London. US Banks and other global organizations with
operations based in the UK will most likely reduce both their presence and
investment inflows in the country.
Another loss to the EU is the UK’s contribution to the EU budget. This leaves Germany and France as the major
EU budget contributors. The EU has
already begun to expand its base of members and privileges in an effort to
replace the potential loss of the UK.
Bank of England (BOE) Governor, Mark Carney, announced that it has been
providing liquidity to some banks and announced that its top priority is to
provide liquidity to avoid any financial stress in the UK market. The BOE had been expected to gradually raise
rates but will now be lowering them and being more accommodative to markets. The British pound fell to 31 year lows and
will continue to be volatile as more political news evolves. Interest rates in the UK may be cut and the
BOE will use all of its tools including quantitative easing.
Downgrades
Both S&P and Fitch promptly lowered the UK debt rating from AAA to
AA with Negative Outlook and Moody’s placed the UK on Negative Outlook with the
expectation that they will soon follow with a downgrade. The rating agencies have stated that the
decline in the country rating will not impact the credit rating of UK-based
companies at this time.
GBP Currency
The British pound has already weakened and may decline further as the
markets decipher the impact of the UK leaving the EU. This will lead to a temporary spike in
inflation. The Pound is the most liquid UK financial asset and the immediate
victim of the Leave vote.
Euro Currency
The euro has declined in response to the UK vote. A weaker currency will negatively impact
foreign investors invested in EU stocks.
Even if stock prices rise in the near-term, it will not be enough to
offset the decline in currency.
Economists are now expecting lower growth and increased job losses
across Europe. High quality (German,
French) European government bonds continue to be in high demand in spite of
negative interest rates.
Other Global Markets
The UK represents only 4% of the global economy. The US and Asia markets have been slightly
affected by the UK’s exit from the EU and in some cases US bonds and Japanese
stocks have benefited as investors seek out safe haven assets. In the UK, large cap UK companies with global
operations will actually benefit from the drop in the British pound as 75% of
them generate revenues outside the UK.
They will outperform the domestically focused UK stocks that will
experience the adverse effects of a UK recession.
