OREANDA-NEWS. June 27, 2016. Unexpectedly, Britain has voted to leave the European Union. The prime minister has announced his resignation, effective by October. This time the pollsters got it mostly right and the odds makers got it wrong. Markets, which had rallied in the days leading up to the vote also got it wrong and are paying the price today. As of 5:00 A.M. EDT equities are sharply lower in Europe. The FTSE 250 index of UK stocks is down 7 percent, but had been down as much as 12 percent shortly after the start of trading. The pound is down 6.4 percent but it was down as much as 11 percent earlier. The EuroStoxx 50 index of Eurozone equities is lower by 8 percent, following a similar move by the Nikkei in overnight trading.

U.S. futures markets are pointing to a lower open, although modest by comparison, with S&P 500 e-mini futures down 3.2 percent. Safe haven bond yields have plunged. The yield on the ten-year gilt is down 30 basis points to 1.07 percent. The ten-year Treasury is down 20 basis points to 1.53 percent. The ten-year German bund is down 18 basis points to -0.09 percent. In contrast, more speculative sovereign bonds at the periphery of the Eurozone have come under selling pressure. Yields in Greece are higher by 91 basis points, in Portugal by 24 basis points and higher by ten in Spain and Italy. The dollar is higher, as is the yen. Commodity prices are generally lower with the exception of gold, which is higher by 5 percent.

A Historic Decision: How Could it Impact the World Economy?

The final vote was 52 percent to leave, 48 percent to stay. And although the referendum is not binding, the margin of victory is enough to mean that eventually the government will set in motion the procedure to break away from the EU. Once that provision of the Lisbon treaty is invoked, a two-year clock to negotiate the terms of exit begins to count down. It is likely that the remaining members of the EU will negotiate tough terms to avoid encouraging others to consider leaving.

It remains to be seen what the economic impact of this historic development will be. No doubt the city of London will be diminished as a global financial center. Global banks have already indicated their likelihood of decamping to elsewhere within the EU should the leave vote prevail. New trade agreements will now have to be negotiated, which will take time and the terms are uncertain. Britain will lose its voice within the EU and the ability to shape its future.

The ensuing uncertainty may well lead to both recession and rising inflation in the UK in the face of the weaker currency. And the future of the EU itself is now clouded, as a rising chorus of populist voices in places like the Netherlands, France, Italy and Spain will no doubt call for reconsideration of their own membership.

The U.S. Economy and Markets Won’t be Immune to Changes Overseas

The U.S. economy and markets will be less affected by this vote than those in Europe, but not immune. The European Union is a major global economic block, and activity will surely slow in the wake of the vote as its implications are sorted out. Demand for U.S. goods will slow, as will demand for commodities, especially if the dollar’s initial move higher persists. Global activity will decline. By how much remains to be seen, but some have now raised the odds of a global recession in their economic forecasts. There are potential security implications of the vote, as a less unified Europe may respond differently to the threat of Russian aggression and the threat of terrorism. And political pundits have speculated that the vote could have implications for the U.S. presidential election.

How events actually unfold from here remains uncertain. The full implication of the vote will emerge in time, and market volatility will likely remain elevated. For now, a defensive stance focused on capital preservation is prudent. Should markets overshoot on the downside, a buying opportunity could emerge. But not yet.
Important Disclosures:       
The S&P 500 is an index containing the stocks of 500 large-cap corporations, most of which are American. The index is the most notable of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill.
The FTSE 250 is a market-weighted index of the250 leading companies traded in Great Britain on the London Stock Exchange.
The Nikkei index is a price-weighted average of 225 stocks of the first section of the Tokyo Stock Exchange.
The EURO STOXX 50 is a market capitalization-weighted stock index of 50 large, blue-chip European companies operating within eurozone nations. The universe for selection is found within the 18 Dow Jones EURO STOXX Supersector indexes, from which members are ranked by size and placed on a selection list. 
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