A Meaningful Financial Market Reaction to the British Vote

July 7, 2016

It was said by proponents of Britain leaving the European Union that predictions of dire financial market and real economic consequences were vastly overstated and that any repercussions would be fleeting and overall inconsequential.  Two weeks of post-referendum experience say otherwise.

Sovereign debt yields have tumbled, suggesting an elevated risk of recession, the possibility of fresh deflation, and even more entrenched expectations that ultra-loose monetary policy will persist for longer.  In the first week after the vote, the 10-year British gilt dropped 51 basis points, while similar yields in U.S., Germany and Japan fell by 27, 22, and 8 basis points.  Over the second post-referendum week, these yields fell by a further 8 bps in Britain, 11 bps in the United States, 4 bps in Germany and 6 bps in Japan.

British and U.S. equities suffered less than their German and Japanese counterparts.  The Ftse-100 actually rose 2.6% in the first week and 0.5% in week number two.  The Dow Jones Industrials slipped just 0.4% in each week.  However, the German Dax lost 5.6% in the initial post-referendum week, followed by 2.7% in the second one.  Japan’s Nikkei likewise lost ground in each week, with the bigger slide of 4.1% happening in the first one and then a further 1.9% slippage in week two.

Commodities behaved as one might expect.  Elevated uncertainty lifted Comex gold by 4.5% in the first week and 3.3% in week two.  But fears of a further global economic slowdown were reflected in declines in the price of WTI oil of 3.6% during the first week and, in contrast to the lessening subsequent turmoil in other financial instruments, an even larger 5.2% in the second week.

Financial services encompass a disproportionately large share of the U.K. economy, so it’s not unusual to see sterling take a huge tumble after the vote to leave the EU.  The pound depreciated 11.0% against the dollar and 7.5% against the euro in the first week.  In week two, sterling lost a further 3.4% against the dollar and 4.0% versus the euro.  The dollar climbed 2.8% against the euro in the first week but only marginally further on net in the second week that ends today.  Against the yen, however, the dollar fell 3.3% in week one followed by another 2.5% in the second week. The currency market moves since the British referendum are thus most worrisome in the case of Japan, an economy already sputtering and regressing toward rather than away from its deflationary past.  The yen has nonetheless strengthened against the currencies of all its trading partners, including the Chinese yuan.  Dollar movements have been mixed, and so have the euro’s.

Far more pertinent information regarding the ultimate impact of the British referendum vote remains unknown than clarified.  It’s too early to see the impact on real economic activity, and even survey data released over the past week were collected largely before the referendum and when the widespread assumption was that the decision would be to stay.  British politics has been thrown for a loop.  The composition of the next government is not known, nor how it will proceed on negotiating Britain’s new financial arrangements with the rest of Europe and other governments around the world.

Another enormous area of uncertainty, the U.S. election, has become even more confusing.  Not since Nixon and the June 1972 Watergate break-in has a presumptive presidential nominee been alleged to have committed possible criminal acts, and those claims didn’t gain traction after Nixon had begun his second term.  This time, it can be said that Donald Trump and the Republican Party are intensifying their role as Javert to Hillary Clinton’s Jean Valjean in a relentless multi-decade fight to the finish.  Trump and the GOP are the oddest of political bedfellows yet a marriage of convenience because of shared beliefs on how to mold the Supreme Court.  A triumphant Trump will send America and its role in the world — both economic and geopolitical — into its biggest change of a lifetime.  A win for Clinton will not end her opponents’ witch-hunt or the paralysis of Washington politics unless the balance of power in Congress changes much more radically than I expect.  The first of these scenarios would dwarf the impact of the Britain leaving the EU.  No country would be unaffected. With so much yet to play out, the safest bet at this juncture is to assume fragile global growth and insufficient inflation most everywhere.  That so far has not disturbed the dollar’s trade-weighted value unduly.

Copyright 2016, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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