This morning our CEO Rob Stein wrote a good overview of the our view of the US after the British vote to leave the EU earlier. As Rob said, at Astor we are alert for signs of a deteriorating US economy, but we will wait to see them before we further reduce our exposure to US equities.
As we have had more time to digest and confer I thought I would send out a few more points to consider about some of the likely consequences for the US and the world.
First off, we should try and approach this with humility, virtually no one got the vote right as today’s market reaction should make clear. No one really knows what will happen or when. We can make some decent guesses however.
- In the US the biggest short term impact to the real economy would be from the real confidence effect on multinational businesses, in my opinion. If the dollar resumes its rally from 2015 (even after today’s rally, it is still below the highs set in January) that could cause an additional slowdown in US exports. I also see a danger that the US could resume its manufacturing slowdown from last year due to the combined confidence and dollar effects.
- What about the US markets? Large cap stocks are more exposed than the rest of the economy to overseas conditions. Safe haven demand as well as expectations for lower growth have combined to move long term bonds higher in price, lower in yield. This is a poor augury for financial firms who were marked down a great deal in today’s trade. The Fed is very unlikely to raise rates any time soon. Expect to see large changes in employment or sustained increase in inflation before the Fed starts threatening another hike.
- The process for the UK to leave the EU is complicated. They have to submit notice they are going to leave which, I presume, will take a parliamentary vote given that this referendum was non-binding. Negotiations for the terms of exit then begin and have to be completed in two years from notice. Leave campaigners have said that some point along the way the UK will try and arrange a deal with the EU on continued market access. Those second, market access negotiations could be difficult or easy depending on attitudes of the two parties.
- I see worries about the breakup of the EU as overblown. No other Eurozone country can leave as easily as the UK because of the shared currency and Eastern European countries feel geopolitical pressure to stick close to the EU.
- I think the main casualty will be confidence, hit hardest in the UK, to a lesser extent in Europe and to a still smaller degree in the rest of the world. Nothing will change for UK exporters tomorrow or even next year. The UK is still in the EU, it has merely voted to leave. The process even if started tomorrow would take two years by treaty so nothing need change this or even next year.
- The hit to confidence, however, could be substantial and sustained. In the real economy think deferred investment and hiring, perhaps canceled with no obvious new opportunities to make up for lost opportunities in Europe. Many economists are now expecting a recession in the UK in the second half of the year and significantly slower growth in Europe. In the event of a recession in the UK we will likely see rate cuts from the Bank of England. These would be mere tokens, however, as rates are already so low so I would also expect another round of Quantitative Easing in the UK as well.
- The confidence hit to the financial world needs little elaboration. US stocks down 3% and safe haven assets rallying strongly. Our contacts on trading desks are reporting brisk but orderly, two sided markets. In my opinion part of today’s trade is leveraged players needing to reduce positions because of risk models. Typically volatility dissipates only gradually after a spike.
- Beyond exporters and equities, part of the confidence effect is a sense that the developed world is retreating from globalization. World trade is already down relative to world GDP growth. In the US anti-immigrant and anti-free trade stances are in my opinion becoming more popular. Some of the fear in the markets today is of that process playing out.
- In the long run the costs to the UK may be as modest as a few tenths of a percent of GDP a year. Compounded, it adds up to loss in welfare, but even a recession in the UK is unlikely to have a debilitating impact on the US. In the long run, if the UK can effect an orderly exit or simply remain in the EU (unlikely, but possible) expect little structural damage to the US.
As always we will be monitoring developments in the US economy carefully as we adjust client portfolios.
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