Global equity markets ended the week sharply down as the United Kingdom voted to leave the European Union. Although some of the decline can be attributed to gains achieved during the previous few sessions, most of the erosion in the global equity markets stems from uncertainty.
The roadmap for how Brexit will occur from a logistical perspective should become clearer over the next few months. Nonetheless, financial markets did not hesitate to price-in the worst-case scenario.
Within the EU, the largest degree of uncertainty centers on other nationalist movements gaining momentum on the European continent and forcing additional referendums. A hard landing for the U.K. economy will make that scenario unlikely.
Additionally, Northern Ireland and Scotland could both attempt to leave the U.K. after voting heavily in favor of staying in the EU. Several of these nationalist scenarios will play out in the coming year as elections are held in many of the continent’s larger countries.
In the U.S., the impact of Brexit was immediately felt in the nation’s stock and bond markets. The 10-year Treasury dipped to near an all-time low before rebounding in to the mid-1.5% area.
As more capital pours into the safety of government-backed bonds, the dollar will continue to strengthen. In the first day of trading after the historic vote, the pound surrendered around 10% of its value to the dollar. A strong dollar will dampen the attractiveness of American exports, weighing on a manufacturing sector already enduring a recession.
The news for those who can take advantage of low interest rates is reason for optimism.
Since 30-year mortgage rates are largely tied to U.S. Treasurys, homebuyers should enjoy sub-4% interest rates into 2017.
When the Fed does raise rates, perhaps in December, a 0.25 basis point uptick will have little impact on mortgage rates. An additional two or three hikes will be necessary to move the needle on consumer loans, including mortgages and auto financing.
Beyond the initial shock of Brexit, there will be several significant long-term implications. On the surface, the U.K.’s departure from the EU should have a relatively minor impact on the fundamentals of the U.S. economy.
As panic fades, the split between the U.K. and EU will appear more manageable for global markets to absorb. However, if voters lose faith in the power of central banks and nationalist parties gain favor, Europe and the rest of the world could be in for a bumpy ride.
