On June 24, 2016, citizens of the United Kingdom voted to leave the European Union in a move that has been termed “Brexit.” The referendum has affected and continues to affect not only the British economy, but also financial markets globally.
In the wake of the Brexit vote, investors have looked to channel their capital into what are considered “safe haven” assets. One such asset is a U.S. Treasury bond. In fact, the demand for U.S. Treasury bonds was so high in the days following the vote that the price of those bonds set an unprecedented record. Immediately after the vote, all U.S. indices declined by about 5 percent as many U.S. investors traded their holdings of equity for such Treasuries.
Interestingly, however, within two weeks of the vote, the S&P 500 index reached an all-time high. A Wall Street Journal survey of leading economists found that the Brexit decision did not result in major changes to projections for economic growth in 2016 and 2017 and did not significantly affect forecasters’ outlook on the U.S. unemployment rate.
Another significant impact of Brexit in the U.S. has been the Federal Reserve’s postponement of interest rate hikes due to the unpredictability of the global market. This move threatens to maintain a low consumer consumption rate if interest rates are kept low over the long run. However, holding off on these interest rate increases can have a positive result: it leaves U.S. markets with enough liquidity to go even higher.
The International Business Times posits that there are two key reasons Brexit is having a less substantial impact on the U.S. market than on other markets. The first is the aforementioned pause in the Federal Reserve’s plan to increase interest rates. The second is the relative insulation of the U.S. economy: only about 15 percent of U.S. GDP is related to international trade. Further, trade between the U.K. and the U.S. constitutes only 0.5 percent of U.S. economic activity.
However, U.S. companies that often do transactions with the U.K., or operate there, are quite invested in the results of exit negotiations over the next two years. PricewaterhouseCoopers has posited that U.S.-based firms are more likely to have exposure if they have sensitivity to any of the following: the health of the U.K. economy; the tax, regulatory, and legislative landscape in the U.K.; how goods and services move between the U.K. and the EU; and free movement of people between the U.K. and the EU.
PricewaterhouseCoopers has also predicted four potential outcomes from Brexit negotiations, and believes that the more distance the U.K. puts between itself and the EU, the more disruptive the process will be for U.S. businesses.
One such potential outcome is that the U.K. remains part of the European Economic Area and retains the four freedoms of labor, capital, goods, and services at the price of contributing substantially to the EU budget and complying with EU regulations. Another possibility is that the U.K. negotiates a Free Trade Agreement with the EU in which tariff-free trade in goods would occur between the U.K. and the EU. Alternatively, the U.K. could enter into a bilateral integration treaty with the EU, meaning the U.K. would have access to certain EU market segments at the cost of adopting the relevant EU regulations. Finally, it is possible that the U.K. does not establish any new trade agreements with the EU, meaning the EU would treat U.K. goods and services identically to those from any other nation outside the EU.
PricewaterhouseCoopers predicts that within the next two years, if the dollar strengthens further against the pound, there will likely be a drag on U.S. exports to the U.K. In the near future U.S. businesses will also have to adapt to changes in the U.K.’s commercial environment, including regulatory changes. What lies ahead in the long term for U.S.-based firms doing business in the U.K. is largely unclear and could present both risks and opportunities for those businesses.