Brexit Shocked Global Markets – Now What?

I’m sure by now you’ve heard all about the Brexit drama.

Just two weeks before the vote, polls were showing the “Leave” campaign was slightly ahead.1 Later surveys however, showed that 52% of Britons were going to vote to stay in the European Union (EU).2

In other words, the average of opinion polls was suggesting the Brexit was too close to call. Anything could happen.

But in the betting market the story was different. Bookmakers were putting the chance of remaining at around 90%.3 So the market and the media ran with the story that U.K. leaving the EU was highly unlikely.

Instead of focusing on the polls, the financial markets were focusing on the bets the bookies were making. At the end, the gamblers turned out not to be a good representation of the electorate as a whole.

That’s why Brexit shocked the markets around the world.

Global stock markets lost about $2 trillion in value on Friday after Britain voted to leave the EU. The British pound suffered a record one-day plunge to a 31-year low.4

And the drama could be far from over.

The Top Two Questions Investors Need to Answer
Since Brexit creates tons of uncertainties, it should continue to dominate the headlines in the coming months. You’ll hear tons of theories and opinions in the mainstream media. But at the end of the day, investors should focus on two important questions.

Question #1: How will central banks react?

There’s no question the Brexit is bad news for the markets. It creates a lot of uncertainty. But it does not guarantee a crash or a bear market in stocks. And that’s mostly because nobody knows how central banks will react to market downturns. Major central banks could easily implement a new round of emergency policy easing.

The Bank of England, European Central Bank and the People’s Bank of China have all said they were ready to provide liquidity if needed to ensure global market stability.5

The U.S. Federal Reserve also said it is “carefully monitoring developments in global financial markets, in cooperation with other central banks, following the results of the U.K. referendum on membership in the European Union.”6

It also said it is “prepared to provide dollar liquidity through its existing swap lines with central banks, as necessary, to address pressures in global funding markets, which could have adverse implications for the U.S. economy.”7

Investors have already adjusted their expectations for the Fed’s next interest rate move. Until recently, they were projecting a one-in-three chance of a rate hike in September. Now the fed-funds futures market is projecting that the Fed won’t raise U.S. rates until early 2018. Some investors are even projecting a slim chance for a rate cut this year. That’s quite a turnaround from this past December, when Fed policy makers were projecting four hikes this year.8

That’s why it’s important to monitor how central banks will respond to any market turmoil. As the last few years have shown, their actions can have a big impact on asset performances.

But while central bank actions are important, there’s an even bigger question investors need to answer:

Question #2: Is Brexit the beginning of the end for the EU?

The real danger of Brexit is that it could destabilize the 28-member bloc by prompting more referendums. This is especially true in the southern periphery, where countries are in far worse economic shape than the U.K.

Italy, Spain and France are all experiencing extremely high unemployment and endless recessions. People in those countries have good reasons to be unhappy with the EU. And the Brexit could give them a big incentive to leave the EU too.

That’s the real reason markets are freaking out. This could be the beginning of a Eurozone break-up, an event that could have implications as serious as a global financial crisis.

The Winners and Losers of Brexit
Like any other big market event, there will be winners and losers. Which financial assets are likely to prosper in the coming months? And which ones are more vulnerable?

To get the answer to that question, you just need to look at the performance of assets around the globe when the news of Brexit hit the media.

With so much uncertainty, investors flocked into traditional safe-havens, such as U.S. Treasury bonds, the Japanese yen and gold. The yellow metal, for example, soared as much as 8% to its highest in more than two years.9 Meanwhile, stocks plunged around the globe.

For now, there’s only one thing that appears certain: over the next few months, investors around the world will likely be facing tons of uncertainty. And that s usually bad news for stocks, and good news for safe-haven assets, such as gold.

Until the next Daily Pfennig® edition…

Mike Meyer
Vice President
EverBank World Markets, a division of EverBank