It didn’t take long for the shock waves of the British exit, known as “Brexit”, from the European Union (EU) to be felt across the globe. In the days since the historic June 23 vote, the financial markets took a sharp tumble, the possibility of a Federal Reserve interest rate hike before year end became more improbable and chatter grew louder of other countries following the United Kingdom’s (U.K.) lead.
PNC’s economic and investment professionals respond to seven crucial questions about what this means for the stock market and economy:
1. Why was there such a violent reaction to Brexit in the stock market?
Two words: Surprise and uncertainty. Financial markets don’t like either one, and Brexit brought both, PNC Chief Investment Strategist Bill Stone said. “Markets were caught on the wrong side of this situation because the odds were saying it wasn’t going to happen.”
Add to that the fact that no one knows what happens next, and you’ve got anxiety. The Brexit vote has no legal power itself. To enact the Brexit, the U.K.'s parliament would need to trigger Article 50 of the Treaty of Lisbon to start the two-year negotiation period preceding the U.K.'s formal withdrawal from the EU.
He added: “No country has ever voted to leave the EU, so no one is exactly sure how it will play out. The U.K. will want to strike a trade deal with the EU, one of its biggest trade partners. It’s a little like a divorce – bad words will be spoken, but they’ll need to come to a deal for the sake of the children, so they’ll get there. Until then, there will be uncertainty, and market volatility will remain the watchword for a while.”
2. Which stocks are taking the brunt of the hit?
The global equity markets are suffering since the vote, with the financial services sector among the hardest hit. Those sectors that benefit from low interest rates, such as utilities, master limited partnerships and real estate investment trusts – and those less affected by the economy, like consumer staples – are out-performing right now, Stone said.
3. Are there opportunities for investors in times of uncertainty like this?
“It’s worth keeping in mind the relative value of stocks,” Stone said, noting that dividends remain secure at the moment. “It may be an opportunity to nibble in that area vs. bonds.”
4. Besides stock market swings, what other ways can Brexit affect the U.S. economy?
“Direct exposure from Brexit is fairly limited in the United States, as domestic exports of goods and services to the U.K. make up only about 0.7 percent of our GDP, said PNC Deputy Chief Economist Gus Faucher. “It’s the indirect impact that we’re more concerned about.”
Consumers could become more cautious because of stock market volatility, businesses might pull back on hiring and investment, and a stronger U.S. dollar makes our exports more expensive. “These are the things we’ll keep an eye on,” he added.
5. Any good news for the U.S. economy from this historic vote?
Long-term interest rates have come down, Faucher said, citing a drop in the 10-year Treasury yield to below 1.5 percent since the June 23 vote. "That means long-term borrowing costs on mortgages are declining, which should boost an already-strong housing market and help put more cash into households through mortgage refinancing."
6. Does this mean short-term interest rates won’t rise any time soon?
“Janet Yellen, the Federal Reserve chair, looks very smart right now,” Faucher said. “One of the reasons she gave for not raising the fed funds rate in June was concern about the international outlook and the uncertainty there. It looks like the Fed made the right move, in our view. We think they’ll want to wait to see how things play out.”
PNC has adjusted its interest rate forecast since the Brexit vote, now anticipating the next rate hike in December – “essentially a full year from the last increase in the short-term rate,” Faucher added.
7. What happens to the British economy and political situation now?
Brexit could be a significant drag on British capital spending and hiring in the second half of 2016, said PNC Senior International Economist Bill Adams. “It’s likely to result in a recession there, in our view, with declining GDP and rising unemployment. We believe the the Bank of England will probably cut interest rates in the second half of this year and could restart its quantitative easing program.”
For more information on Brexit, see the full economic report from PNC’s economists
The direct effect of a Brexit vote on the United States is limited by the U.S. economy’s small direct exposure to the U.K., but global financial volatility after a Brexit could affect the U.S. economy more concretely.
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