Brexit: Navigating through the uncertain climate

The world watched in disbelief as the UK decided to opt for Brexit i.e. leave the EU. After the vote, we have already seen a weaker pound, increased UK exports and stock-market rallies. However, the fact is that the UK has yet to leave the EU and the long-term implications of the move are not yet clear. Although exit negotiations between the EU and the UK have begun (Article 50), unraveling 40 years of union is no mean task. While capital markets seem upbeat about the decision, the signs elsewhere are not so positive.

The story so far

  • Weak currency and reduced credit rating: Sterling plunged to a 30-year low, driven by the Bank of England’s economic stimulus measures. The weaker currency stimulated demand for cheaper UK exports, but also led to a 7.6% increase in cost of materials and fuel for UK manufacturers. Within days of the vote, the UK lost its prized AAA credit rating. Currently, it is impossible to predict where the pound will be by the time the UK finalizes its new trade agreements. There is a possibility that such currency movements may result in the outflow of capital from the UK and the EU towards ‘safer havens’ such as the US and Japan. What’s more, the reduced credit rating will increase the cost of government borrowing, leading to either reduced borrowing or limited public spending.
  • Uncertain business environment: Business stakes are high as almost 63% of UK exports go to either EU countries or those covered by the union’s free trade agreements. That is why, business confidence currently is quite fragile. While some companies have already announced their decision to leave the country, others are developing plans to limit the damage of the exit as well as quantifying the cost of a “hard” Brexit: USD 607 million of profit for Nissan, and USD 750 million of revenue for Credit Suisse.
  • Financial services sector in panic mode: It appears likely that London-based banks will lose their ‘passporting’ rights, which allow them to sell their services across the EU. This will affect the UK financial sector severely. Already, JP Morgan CEO Jamie Dimon has announced that the bank would transfer 1,000 jobs from London if the rights are lost, while Goldman Sachs plans to displace 3,000 jobs (half of its UK workforce) to various EU countries. Other firms (such as Citigroup) plan to establish dual operations centres and split their activities between EU countries and the post-Brexit UK.

Implications for US investors
The relative isolation of the US economy and the delaying of an interest rate increase by the Federal Reserve due to the vote meant that the Brexit decision had a limited impact on US investors. Most American investors are expected to consider domestic economic trends first for guiding their decisions. Several of them are moving their capital away British gilts and towards US Treasury bonds and gold. Before taking any step, a US investor should consider the extent of its exposure to the UK economy, how the country’s tax and regulatory environment will affect it, and free movement of workers and goods.

What does the future hold?
Elections in Germany and France in 2017 will add to the uncertainty of the climate in which Brexit negotiations will take place. In the short term, market sentiment will be determined by the country’s exit terms with the EU. After Brexit, trade prospects will be dependent on the country’s relations with non-EU nations (notably the US and its protectionist president) and its engagement with organizations such as the WTO. Overall, investors are advised against making impulsive moves in response to events that will unfold. Keeping abreast of the developments will suffice at present.

Elizabeth Parrott is a director at Evalueserve. She will participate in the FPANorCAL conference in San Francisco on May 30–31, 2017. There, she will discuss the issues raised in this blog and share more implications for US investors.

Read more on the topic in our recently published industry insights – Brexit: What US Investors Need to Know.

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Elizabeth Parrott
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