In an expectedly close but surprising vote, the U.K. has completed a referendum to endorse a withdrawal from the European Union (EU). The market reactions are the usual result from market uncertainty around economic issues—sell-offs in “risk assets” such as stocks and currencies and a flight to quality in “safe-haven” currencies and bonds (e.g. the U.S. dollar and Treasuries).
Early analysis of the results indicates, however, that the long-term results may not be as severe as feared.
Here’s What Happened
U.K. and Commonwealth voters, by a slim margin, voted to leave the EU. Prime Minister David Cameron immediately resigned, and a new government will be installed in the fall.
What Happened In The Markets?
- Stocks and other assets, such as currencies, have sold off around the globe. The U.K. and other EU countries have been hard hit, while the U.S. decline has been muted. Leading up to this, the global markets were rebounding over the last couple of weeks.
- The U.S. dollar and Japanese yen have strengthened; the Euro has declined a bit, and the sterling has substantially declined against the dollar.
- There has been a flight to quality in bonds, particularly U.S. Treasury Bonds.
- Gold has been priced up, while oil has declined.
Why Were Markets Volatile?
- Many believed that Britain would remain in the EU and short-term traders made heavy bets in currencies and other “risk assets.” In fact, markets rallied into the vote as the DJIA was up over 250 points last week. Interest rates were moving higher.
- The markets were surprised once the votes were tallied and markets reversed their trend, giving back most of these gains. The behavior was violent, as Britain leaving the EU is a significant event.
- The U.S. markets declined as the thought process is that European companies are trading partners of the U.S. This could be negative for some businesses.
What Are The Longer-Term Effects?
- Britain represents 4 to 5 percent of global GDP (gross domestic product). Net results may not be that significant.
- The U.K. will need to implement policies to provide liquidity and ease interest rates.
- Sterling will fall, U.K. inflation will increase due to increased import prices, and U.K. GDP will likely decline in the near-term. A recession is possible in Britain.
- The U.S. will be relatively insulated. The Fed will likely delay interest-rate hikes.
- Global growth may be affected to some degree. This event is not a ‘Lehman moment’ that accelerated the global financial crisis. As one pundit noted, “…markets adapt. Policymakers adjust. Businesses will change course while they continue to seek profits. Prices will reset. Opportunities will emerge.”