The Brexit Moment of Truth

On Thursday, British voters shocked Europe and the world by voting not to continue to be part of the European Union. The vote is momentous for Europe as a whole, a now failed test of whether the union can hold together in the face of myriad challenges like the Syrian refugee crisis, disparities in wealth and economic health between north and south, and debt problems like those posed by Greece, Spain and Italy.  Strong anti-EU parties in Germany, the Netherlands, Greece, Spain and Italy will certainly be emboldened now that Britain has voted to secede from the EU.

British Prime Minister David Cameron was strongly in favor of staying in the EU, as was much of his Conservative government, the Labour Party, the Liberal Democrats and the Scottish National Party. Cameron has now announced his resignation.  Ironically, with “Brexit,” the Scottish people might vote to exit Britain and join the EU on their own.

On the other side, Brexit was championed by many lower-wage workers in Britain who view EU membership as an attack on British sovereignty. 

What now?  With an “exit” vote, British companies could lose access to the consolidated European market for duty-free trade and financial services.  Some analysts think that London might be unable to function as Europe’s de facto financial center if Britain were no longer a part of Europe’s union.  And U.S. companies have long seen Britain as the gateway to free trade with the 28 nations in the European Union, which explains why American corporations and Wall Street firms donated substantial sums to the “stay” campaign.  Britain could lose American investment and manufacturing jobs that might well move across the channel to mainland Europe instead.

Add it all up, and the International Monetary Fund has predicted that Brexit could reduce British economic growth by up to 5.6 percent in the next three years, partly driven by a sharp decline in the British currency.  Indeed, the British pound lost as much as 11% Thursday night into Friday morning as the voting results became known. Meanwhile, you may have noticed that the global investment markets have become noticeably choppier in the run-up to the vote (mostly on the upside, as polls and the markets had most recently been confident the vote would go the other way).  The  British “leave” vote will create still more volatility, initially on the downside, which is why Fed Chairperson Janet Yellen has already mentioned the referendum overseas as having an influence on the decision of whether or not to raise interest rates in the U.S.

The vote was expected to be close. Indeed, the odds-makers in Britain had given 73% odds on a “stay” vote. Yet it wasn’t to be. As with virtually all unexpected global political shocks with uncertain consequences, the markets are reacting negatively. Yet markets also have a habit of recovering fairly quickly when these events occur. The likely transition will be a long-term but ultimately graceful accommodation between the UK and Europe.  The formal European Union “exit clause” sets forth a two-year period of negotiations between exiting countries and the remaining union. So for the near-term future, despite what you might read elsewhere, the UK is still part of the Eurozone.

Market volatility will likely be high for some time. Investors virtually always do well to stay calm when the markets get crazy. Now is one of those times.  


Article adapted from a Bob Veres draft with permission.