Implications of Brexit!

   Schwaben Blog

June 30, 2016

 

Monthly Statistics:

  Today Month Ago Year Ago
  30-June-16 30-May-16 30-June-15
       
S&P TSX 14,100 14,226 14,743
S&P 500 2,093 2,099 2,079
DJIA 17,800 17,807 17,766
OIL $48.50 $48.70  $62.66
USD vs CAD 0.7742 0.7742 0.8303
Gold $1,324 $1,246  $1,172

 

So far the year 2016 has had no shortage of major events and one event that will go down in the history books is Brexit, short for exit of Britain from the European Union. The markets and the oddsmakers were caught off guard by the U.K.’s historic vote to leave the European Union on June 23. The shocking news sent ripples across the global economy and sent the pound down to its lowest level in 31 years. The equity markets across North America were also down sharply.  After Brexit, Scotland and Northern Ireland, afraid of being left out of Europe, are also preparing for a referendum to leave the UK and stay in the European union. That referendum has already gathered more than 3 million signatures. Whether Scotland and Northern Ireland will stay with the UK or not is still undecided, but the most important outcome of Brexit is that the business investment across the Europe will be dampened due to the heightened uncertainty of the implications of Brexit. London’s image as the financial hub of the world is in danger now as major investment banks and financial institutions are looking to cut jobs there and are planning to set up new branches in Dublin, Luxembourg and Frankfurt to have continued access to the EU nations.

While this is a major event in global economy, it is still unlikely to seriously hurt the US and the global economy.  According to Factset, UK is the third largest generator of revenue for the S&P 500 among the US trading partners, but it’s still pretty small. Sales from the UK make up just 2.9% of the overall revenue of the S&P 500. On the global level, the UK accounts for only 3.6% of global imports of merchandize goods and 4.1% of global imports of commercial services, so even if there is a recession in the UK (which is highly likely), the direct effect on global GDP should be minimal.

When markets are awash with fear and uncertainty, investors tend to run towards the safe haven, usually Gold or US treasuries. This flight for safety pushed the US treasuries almost to the lowest level in four years and strengthened the US dollar against major currencies.  A further strengthening of the dollar in response to global risk aversion would be a problem not only for U.S. growth prospects but also for all the dollar debtors in emerging markets, and could also push commodity prices lower. Also, roughly half of S&P 500 revenues are from other countries and any further appreciation in the USD would dampen the prospects of near term growth in the index’ EPS. At this juncture, the US economy might be strong enough to tolerate the normalization of monetary policy but the global economy is much more vulnerable to the Fed’s moves. After the outcome of the the Brexit referendum a rate hike in July is completely off the table and with the US presidential race in full swing, a September rate hike has very low probability as well. Central bankers across the globe also vowed to take further steps to limit any economic fallout. With additional stimulus expected from Bank of England, Bank of Japan, and European Central Bank, any interest rate hike by the US Fed would send the dollar through the Stratosphere.

 

 

 

 

Source- Bloomberg, Globe Investor, Financial Post, Market Watch, FactSet, Trading Economics

 

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