The world awoke to the most momentous political shockwave of the year as the U.K. voted to exit the European Union. The EU has responded that it wants the UK to quickly negotiate the terms of its exit, which it must do within two years. Prime Minister David Cameron has announced that he will resign, but will stay on as his Conservative party finds a successor.
The market moves were as violent as predicted. The British pound sterling fell as much as 11% -- the biggest drop ever in one day – before retracing by about 4%. Overnight it hit levels not seen since 1985, and now is at levels last reached in the aftermath of the Great Recession. US 10-year yields fell from 1.70% down to 1.40% before coming back right near the middle of the range at 1.57%. Equities are down around the world and the German 10-year bund is in record negative territory.
There are three major takeaways from this:
- Polls did not capture the amount of emotion surrounding this vote. Even more wrong were the betting markets, which had a 80% chance of the Remain camp winning all the up to the closing of the polls. It was only after the first few votes were counted when market realized how wrong they all were.
- Markets are volatile right now, but will settle down at new equilibriums and new expectations for this year. Notable for the U.S. is that Fed rate hikes have been virtually priced out for this year. In fact, Fed Funds futures are pricing a small chance of a rate cut over the next three meetings.
- This will embolden other separatist movements in Europe to move ahead. We already see such pressures in France and Italy. And while it seems functionally impossible at the moment, there is renewed questioning of the euro currency. German Chancellor Angela Merkel is doing everything she can to keep the EU together. She notes that it was meant to keep the peace and improve people’s lives, but clearly there are significant segments of the population that disagree.
Our View: The dust will have to settle on this, but we can’t emphasize enough that this is a game changer for Europe and will resonate throughout the world for years to come.
And as always, please feel free to contact us for questions. We are more than happy to discuss what is happening and what it means for you and your business needs.
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