Good Morning. We’re now in to the second day of Brexit’s aftermath and I’m sure everyone has noticed their portfolio’s getting crushed and interest rates moving lower. We find ourselves in the classic flight-to-quality scenario, not unlike the Chinese currency devaluation episode recently, where investors are shedding risk and moving in to the safe havens of government bonds and mortgage-backed securities. So what’s the big deal? It seems like we’ve been in a constant flight-to-quality since I graduated high school. The difference now is that 50 years of European integration and the entire concept of globalization is suddenly on the ropes. What’s going to happen next? Who knows… It’s that UNCERTAINTY that’s driving markets in to the ground right now.
By being a member of the European Union, the UK enjoys free movement of goods, services, trade, people, etc. with the rest of Europe (and by extension, the planet Earth); an advantageous arrangement, as long as they’re willing to live with the EU’s regulations. With the UK’s vote to exit the EU, now everything from trading to exports to immigration has to be renegotiated and put in to the law books. This process could take as long as two years. Naturally, no one has any clue what the post-Brexit UK is going to look like or what kind of agreements are going to govern trade or immigration. As a result, I don’t see investors lining up to invest in the infrastructure in the UK in the foreseeable future.
A few other things to consider…. There’s the very real possibility that Scotland has their own referendum to leave the UK and stay in the EU. That would have a massive impact on the UK. Also, think about buying a home there – there are 2 million non-British residents in the UK. Are those people taking advantage of the rate environment and buying homes or starting businesses when there is the very real possibility that their legal status could be in question? What about London? London has been the financial center of Europe for centuries. That’s DONE. Think about the potential political chaos in Europe. Perhaps we see a “Tea Party for BREXIT’rs” in the rest of Europe, further increasing the instability in the region.
The UK comprises 4% of all global economic activity. Because of the factors above, we’re probably looking at the very real possibility of a recession in the UK later this year. Perhaps that spreads into the Eurozone and ultimately, the United States. There will be effects here. I think the selloff in the American equity markets is proof enough. A Fed rate hike in July is pretty much off the table and quite possibly off the table for the remainder of 2016. We’ll have to see more data before solidifying our stance on that last point, but keep in mind that economic data we’re going to see over the next few weeks will be pre-BREXIT vote and stale. Next Friday’s employment report will, for the most part, be severely discounted because of this. I think you have to drop GDP forecasts considerably…maybe in to the sub-2% range for the next two years.
Shoot me your questions. This is going to take some time to work through, but I hope this answer some questions…or at least presents some.
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