Brexit’s Impact on Global Markets

Posted by Laura Sarlo, Senior Sovereign Analyst on May 20, 2016 1:48:27 PM

Brexit-v2-1.pngThe upcoming June 23rd UK referendum on European Union (EU) membership appears to be a knife’s edge contest. If the vote produces an “out” result, I believe the global markets will face additional turbulence this summer. I also anticipate that credit ratings agencies will penalize the UK for an “out” vote.

There are (at least) two challenges causing anxiety in the markets now as we face a potential Brexit:

Financial markets are not terribly good at pricing political risks. Most market participants have more expertise pricing financial risks (credit, maturity or inflation risk), compared to pricing political risk.

The usefulness of UK polls is in question. The polls proved to be far off base in the lead up to last May’s general election. The last polls ahead of that vote suggested the Conservatives and Labour were essentially tied (with neither likely to win enough seats to govern without a coalition partner.) The actual result produced a decisive victory for the Conservatives, handing them a large enough majority to govern alone.

Brexit Is Already Causing Pain

  • Sustained depreciation pressure on the British pound, some of which is related to Brexit risks, and some related to weakening interest rate support for sterling as markets priced out expectations for the Bank of England’s first rate hike.
  • Underperformance of UK bank assets as many expect the financial sector to be negatively impacted by a potential “out” vote. Upon an “out" vote, the UK financial services industry would likely face increased transaction costs compared to the current status under the European Single Market.

I agree with market expectations that the ensuing negotiations post-Brexit will be both noisy and prolonged over at least one to two years, which creates fertile ground for tumultuous swings in financial markets.

In the end, however, I expect that beyond the noise, the UK will remain a solid sovereign credit with a sound policymaking framework supporting a dynamic economy that is competitive on the global stage.

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This blog post is provided for informational purposes only and should not be construed as investment advice. Any opinions or forecasts contained herein reflect the subjective judgments and assumptions of the authors only and do not necessarily reflect the views of Loomis, Sayles & Company, L.P. This information is subject to change at any time without notice.

Topics: Macro Strategies, Sovereign Research

Loomis Sayles analysts are career professionals who offer deep knowledge and experience in a diversity of global asset classes and market sectors. These dedicated experts provide the insight essential to supporting our portfolio management teams across a wide range of investment strategies.


 

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