‘Brexit’ Expected to Rattle U.S. Economy, Shake Its Influence Britain’s exit from the European Union is expected to jolt the U.S. economy, likely rattling restive equity markets and driving up the value of the dollar. It could also weaken U.S. diplomatic leverage in Europe and upend the corporate strategies of U.S. companies based in London.
Top finance officials say the damage from the so-called Brexit alone isn’t likely to be enough to nudge the U.S. into a contraction. But as skittish investors pull out of U.K. and European markets and pour into the safety of U.S. assets, a falling pound and euro could cause the dollar to surge, further suppressing demand for American exports. (…)
“The U.K. vote to exit the European Union could have significant economic repercussions,” Janet Yellen, chairwoman of the U.S. Federal Reserve, told Congress this week. A Brexit would “usher in a period of uncertainty” and fuel volatility in world markets. “That would negatively affect financial conditions and the U.S. economy.”
U.S. Treasury Secretary Jacob Lew said ahead of the vote, “I only see negative economic outcomes” were voters to decide to leave the EU. (…)
A vote to leave is expected to sour investor and consumer confidence, incite market uncertainty and spoil spending appetites in Europe, maiming the region’s already anemic growth. European officials have scheduled emergency meetings to help calm financial markets and prevent contagion into weaker economies. Many economists say the U.K. could be pushed into a recession. (…)
But the damage won’t likely be isolated to the U.K., the world’s fifth-largest economy. “A Brexit victory will also signal victory for populism in Europe,” said Mr. Kirkegaard. “This referendum has unleashed fairly destabilizing elements into the European project.” (…)
(…) The vote isn’t legally binding, so Parliament now must pass laws to make Britain’s exit happen.
The vote to leave the EU unleashes a yearslong, highly bureaucratic tussle over how to actually achieve that. There is no clear road map. (…)
Under Article 50 of the EU’s Lisbon Treaty, a member can give notice of its intention to leave, opening a two-year window for negotiating terms of withdrawal, meaning the U.K. technically remains a member until its formal departure. The time period can also be extended. (…)
Nationalist leaders in Scotland sent a strong signal before Thursday’s vote that they would push again for secession if Britain chose to leave the EU, and on Friday Scottish First Minister Nicola Sturgeon said the Scottish government would begin preparing legislation to hold a second referendum and that a second vote was now “highly likely.” (…)
There are rough guidelines on how to proceed, but the negotiation will be largely improvised. Estimates of how long it will take range from two years to a decade or more. For officials involved, it is a legal and political no man’s land. One senior EU official said: “We are faced with a million mad questions and we won’t have answers any time soon.” (…)
On substance, what political and commercial arrangements will Brexit Britain demand and will the EU accept them?
In execution, will the exit deal — the divorce and breaking of old obligations — be struck at the same time as a trade agreement covering post-Brexit trade? And if no, is a transition possible to ensure a soft landing?
(…) Speaking on behalf of EU leaders, Donald Tusk, the European Council president, said: “there will be no legal vacuum”.
“Until the UK formally leaves the EU, EU law will continue to apply to and within the UK and by this I mean rights as well as obligations,” he added. “All the procedures for the withdrawal of the UK from the EU are clear and set out in the treaties.”
Lawyers in Whitehall and Brussels see two distinct tracks. The first is under Article 50 of the EU treaties — the so-called “exit clause” — which lays down a two-year renewable deadline for a country to leave.
A second track makes arrangements for future relations, from trade to co-operation on security or law enforcement. This is a more complex negotiation and, once agreed, harder to ratify. It requires unanimity and approval by more than 30 European, national and regional parliaments, possibly after national referendums. (…)
By law, nothing fundamental will change for British companies in the coming weeks, months and possibly years. The formal EU rupture is some time away.
But Britain has been thrown into political turmoil. David Cameron’s decision to step down as prime minister triggers a Conservative party leadership race could take several months to play out. An early general election cannot be ruled out.
Mr Cameron made clear the decision on when to trigger Article 50 is for his successor. That means any formal EU negotiations will not start until the autumn at the earliest. (…)
One of the biggest economic risks is a long wait between Britain’s exit and new trade arrangements. Before the vote, Mr Tusk said if needed, cancelling UK treaty obligations would be “relatively easy” and take about two years. This would settle outstanding bills from the budget and spending projects, the legacy rights of expatriates around the EU and in Britain, and the withdrawal of British nationals from EU institutions.
But he added it would be “much more difficult” to negotiate a new relationship. That would take at least a further five years “without any guarantee of a success”. France and Germany are open to starting such trade talks in parallel with divorce talks, but are unwilling to give any guarantee that the two deals would be rapidly concluded simultaneously — the ideal scenario for Britain. (…)
“There will be a gap,” said one diplomat intimately involved in planning. “It is unthinkable that a [trade] agreement would be in force after two years.”
A hard landing would mean that Britain would be left relying on basic World Trade Organisation trading terms, with no privileged access to European markets for UK companies. A softer transition could be arranged, but it would require agreement among all the remaining 27 members.
If, for instance, EU member states rapidly agree a trade deal, it could be provisionally applied while the lengthy and unpredictable process of ratification begins at national level.
Another option is to temporarily revert to an established model — such as that for Norway — to give Britain full access to the single market while its new trade deal is pushed through. That may be impossible for a Brexit government; for several years it would live by EU rules it cannot influence, pay EU budget dues and accept free movement of workers — just the things many voters rejected in the referendum.
Backers of the victorious Leave campaign are optimistic that common sense will ultimately prevail. Daniel Hannan, one of the most influential Brexit thinkers, pointed in a EuroMoney interview to the example of Irish secession and its bloody birth and aftermath. “And yet here we are nearly 100 years on; we still have a common free movement zone, common social security claims, common voting rights, because it didn’t suit either party to unpick that deal,” he said.
Sceptics think the political omens are less auspicious. “There are no good options, no turning back,” said one senior EU diplomat who will be closely involved in the talks. “The best we can hope for is an amicable divorce and a long-term relationship that is constructive, as opposed to bitter and dysfunctional.”
(…) Europe is still struggling with the slowdown in the eurozone and the most severe migration crisis since the second world war. Across the continent, from Paris to Rome and Warsaw, populism is on the march, the establishment in retreat. Britain’s referendum result may well go down in history as “the pitchfork moment”.
For the UK, the vote has turned conventional wisdom on its head. A country renowned for its conservatism and political stability has taken a leap into the dark. (…) The slogan of “taking back control” resonated with people who see Europe as a continent in disarray. (…)
Beyond Westminster, the split of the vote saw strong majorities to stay in London and in Scotland. The country divided between the big cities, the English shires and the Celtic fringes. This will inevitably raise questions about the territorial integrity of the United Kingdom. (…)
The immediate priority for the UK government must be to stabilise the economy. In the medium term, the country has to find a way to turn this crisis into an opportunity. It will be no easy task. Talk of an “independence day” does not translate into a credible strategy. (…)
(…) Now that the UK has voted to leave the EU, that bear market feels a lot closer.
The seven-year rally in global risk assets, led by US stocks, has been so joyless for two main reasons. First, the monetary policy that has accompanied the rising prices has no precedent, so its long-term effects are uncertain. Second, the rally has been given only equivocal support by corporations’ financial fundamentals. Revenue growth is painfully scarce; bottom lines have been supported by cost-cutting and share repurchases.
(…) Though the direct financial impact of Brexit is not well understood, markets are, rightly, pricing harms that are perfectly foreseeable. A stronger dollar will hurt commodities and emerging market economies. Political uncertainty will delay investment decisions concerning Europe and the UK. There will be a serious discussion of a second Scottish referendum. And this huge victory for populism will force the US to consider the possibility that the frightening ignoramus hoping to lead their nation actually has a shot at getting the job.
Still, for those who have participated only tentatively in the rally, and as such have cash on hand, there is a reason to put that cash to work — slowly, but starting now. One must remember the old point: no one rings a bell when the market hits a low. Those who desire the high returns that have been captured in the past by those who “bought on the sound of cannons” cannot be cute about timing. Further, the schedule for central bank rate increases has surely been pushed further out. While the impact on the UK and European economies will be negative, there is the possibility that the hit to confidence is not as bad as feared and the status quo, in terms of global trade, is sustained for quite a long time. In any case, the UK is less than 4 per cent of the world economy.
Finally, and perhaps most importantly, big, long-term investors such as pension funds and insurance companies are absolutely starved for yield. If a correction makes yield available, they will step in to grab it.
None of this is a suggestion to run out and buy, say British banks. But capitalism is resilient, and those who hated the rally should fight their feelings and learn to love the bear.
Other links:
- U.K. Backs Brexit as Cameron Resigns After Historic Rupture
- What Now? Brexit Win Sets Stage for Two Years of Bitter Talks
- Full Coverage: Britain Votes for Brexit
- How They Got It So Wrong. Complacent Traders Stunned by Brexit
- Bank of England Pledges $345 Billion to Fund Brexit Defense
- Nightmare Coming True for Stock Bulls Blindsided by Brexit
- It’s Time for Europeans to Take a Stand
- Britain’s Out, But Not Gone
STEP IN?
Pre-opening on the S&P 500 Index is 2030, down 3.7%. The Rule of 20 P/E is now 19.4. Since January 2014, corrections stopped at 19.0 except for the early 2016 scare which carried to 18.3. We are back into the “Lower Risk” area although not comfortably.
In highly uncertain times, markets tend to be more influenced by the dark side. Central banks’ tool boxes are near empty and many doubt the usefulness of what’s left in them. Brexit will take time, if it ever happens, but uncertainty will prevail for a while.
Mrs. Yellen will have even more causes to be uncertain, especially with these new data:
RECESSION WATCH
The Conference Board’s Composite Index of Leading Economic Indicators fell 0.2% during May (+1.2% y/y), following an unrevised 0.6% April increase. The decline was the first since January, and disappointed expectations for a 0.2% rise in the Action Economics Forecast Survey. The three-month change in the index eased to 2.0% (AR) versus its peak growth of 7.1% roughly one year ago. Higher initial claims for unemployment insurance had the largest negative impact on the total index followed by declines in stock prices and in consumer expectations for business/economic conditions. These were offset by a steeper interest rate yield curve and slight gains in most other component series.
Important charts from Doug Short:
As we can see, the LEI has historically dropped below its six-month moving average anywhere between 2 to 15 months before a recession. The latest reading of this smoothed rate-of-change suggests no near-term recession risk. Here is a twelve month smoothed out version, which further eliminates the whipsaws:
The National Activity Index from the Federal Reserve Bank of Chicago declined to -0.51 during May, following one month in positive territory. It suggested below-trend overall economic growth. The three month moving average reinforced this notion by being in negative territory since February 2015. During the last ten years, there has been a 77% correlation between the Chicago Fed Index and the q/q change in real GDP.
Each of the component series declined last month. The Production & Income reading fell sharply to -0.32, its lowest point in six months. The Personal Consumption & Housing figure declined to -0.09. The Employment, Unemployment & Hours figure also fell to -0.09, the weakest reading in nine months. The Sales, Orders & Inventories figure was fairly steady at -0.01. The Fed reported that 28 of the 85 component series made positive contributions to the total while 57 made negative contributions.
Also from Doug Short:
The next chart highlights the -0.70 level and the value of the CFNAI-MA3 at the start of the seven recession that during the timeframe of this indicator. The 1973-75 event was an outlier because of the rapid rise of inflation following the 1973 Oil Embargo. As for the other six, we see that all but one started when the CFNAI-MA3 was above the -0.70 level.
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Pace of U.S. New Home Sales Slows Sales of newly built homes slipped in May after touching a postrecession high in April, but the pace still indicates a healthy expansion of the housing sector this spring.
Purchases of new, single-family homes fell 6% in May from a month earlier to a seasonally adjusted annual rate of 551,000, the Commerce Department said Thursday.
April’s rate was cut to 586,000 from an initially estimated 619,000 but still rose 12.3% from March. April’s rate was still the fastest pace since February 2008. (…) Year to date, new-home sales advanced 6.4% compared with the same period in 2015. (…)
May’s new-homes sales pace, meanwhile, keeps the market on track to beat 2015’s total 501,000 new homes, the highest annual level since 2007. (…)
The median price of a new home—the point at which half of homes were sold above and half sold below—was $290,400 last month. That was down from April, and up 1% from a year earlier. Prices aren’t adjusted for seasonal factors.
Thursday’s report showed that inventories of new homes expanded in May. Based on the current sales pace, it would take 5.3 months to exhaust the supply of new homes on the market, compared with 4.9 months during the prior month. The total number of new homes for sale at the end of the month was 244,000, the highest figure since September 2009.
Here’s the chart on the national average:
And here’s the table proving that the national average is meaningless (chart and table from Haver Analytics)
The decline in new home sales was paced by a one-third m/m drop in the Northeast to 34,000 (30.8% y/y) which reversed the prior month’s surge. Sales in the West fell 15.6% to 124,000 and also reversed the prior month’s gain. In the South, sales eased 0.9% to 323,000 (+13.3% y/y) after a 9.4% increase. To the upside, sales in the Midwest increased 12.0% to 70,000 (16.7% y/y), the highest level in two years.
U.S. Jobless Claims Fell as Labor Market Shows Resilience The number of Americans filing fresh applications for jobless benefits fell last week to the lowest level since April, a sign that the job market may be showing some resilience after May’s slowdown in hiring.
Initial claims for unemployment benefits, a proxy for layoffs across the U.S., fell by 18,000to a seasonally adjusted 259,000 in the week ended June 18, the Labor Department said Thursday. (…)
The average over the past two weeks, 268,000, was within a hair’s breadth of both the four-week moving average and the year-to-date average, which is 268,520.
The four-week moving average, which helps even out short-run swings in the data, fell by 2,250 last week to a seasonally adjusted 267,000. (…)
SO?
Yesterday’s news was mostly bad and frightening. The “R” word will be around a lot in coming weeks, maybe months, and not only in Europe.
Thankfully, the U.S. and Eurozone flash manufacturing PMIs were somewhat better.
Anyway, I’m going salmon fishing tomorrow, back next Wednesday.