Brexit. It’s all the rage these days. The word is whispered over candlelight glasses of wine in dark corners at swanky post-market-close cocktail bars. It is spit out over conference room tables amongst such phrases as “contingency planning” and “hedging strategies.” It has everything a news agency drools over, drama with the dark horse effect as the yes vote gains unexpected traction on the very last loop around the track. It provides angry rants that skirt around xenophobia or at least a level of indignant nationalism that can generate eye-catching headlines. It paints the image of a battle of wills between the confident and worldly intellectual, gazing with vague annoyance over wire-rimmed glasses at the rough and tumble, calloused working man who is damn tired of those immigrants stealing jobs. It is a story filled with fear, hope, anger, frustration, isolation and unity. Whatever version of the story attracts you the most, as an investor a “yes” vote for the UK to leave the European Union has two major impacts, currency and uncertainty.
The currency effect means a stronger US dollar relative to the Euro and Pound Sterling. This would make american exports more expensive and imports relatively less expensive. The United States is the second largest exporter in the world, so when our exports become more expensive, that’s harder on everyone buying our stuff so it becomes a headwind to growth. With imports relatively less expensive, Americans are more likely to purchase an imported product than they otherwise would have been, which can also hurt american producers.
The currency effect can also be a problem for emerging markets where companies have issued unprecedented levels of debt denominated in US dollars. As the US dollar rises in value, that debt become more and more expensive, resulting in everything from reduced investment in growth to defaults which are further headwinds to global growth.
The currency effect can also have a secondary impact in its correlation with oil. With oil denominated primarily in dollars in the global marketplace, strengthening dollar means weaker oil prices. This can then affect the sovereign wealth funds from those oil-dependent nations as they are pressured to sell assets in order to pour more back into their domestic economies. This is a headwind to global asset prices.
Overall the currency effect is essentially deflationary for the US, which makes it more difficult for the Federal Reserve to return us to a more normal rate environment, prolonging the negative side effects from low-to-zero interest rates.
The uncertainty effect is all about the impact on companies. Although the word sounds easy enough, Brexit, short, simple and comfortably straightforward, the reality is no one really knows just how this darn thing will pan out! If there is in fact a yes vote, unthinkable a few weeks ago but now looking increasingly like it just might happen, no one is clear as to just how it would be implemented. Then there is the reality that the vast majority of politicians in the U.K., regardless of party, are all against a Brexit, so these folks will find themselves having to enact legislation based on a vote by their constituency that goes against what they believe is best; rock meet hard place.
With the realities of the actual implementation unknown, companies will be much less likely to invest which means less spending/less growth. There will be less M&A activity and the potential momentum of this vote with respect to rising nationalism is a further headwind to already falling levels of global trade which means even slower growth across the globe.
Brexit, the end of french kisses along the Thames?