World financial markets are reeling from a surprise upheaval to the established order.
“Dare to dream that the dawn is breaking on an independent United Kingdom!” said UK Independence Party leader Nigel Farage upon the momentous results of the E.U. referendum.
Brexit will now transition from a mere notion of ‘What if?’, to a reality demanding ‘What now?’. One certainty is that world capital markets were not positioned for such a result.
Reality sinks in
In the days and weeks leading up to the referendum, investors seemingly assumed a hopeful disposition, pushing currencies and indices to near 2016 highs as a ‘Stay’ vote was priced in to the market.
As vote totals indicated a victory for ‘Leave’, the British Pound plummeted to levels not seen since the 1980’s, in its biggest drop in more than two decades. Stock markets open for trading across Asia have sold off while equity index futures in Europe and the United States face large declines at their opening bells.
Capital markets will take days if not weeks to digest the news because the result raises a plethora of political questions that each represent risks in that they are as yet unknown.
British Prime Minister David Cameron has invested so much into staying in the EU that the defeat may necessitate his resignation. Such a move means calling new elections, party power struggles, and competing implementation plans that will further upset the established order and breed uncertainty as to the true extent of Brexit’s effects.
Moreover, much of the tangible economic and financial impacts of leaving the European Union depend upon political negotiations that could last months, if not years, before finally being resolved. Decisions of varying economic and financial significance will cast fluctuating shadows on capital markets along the way,
Immigration has been cited as a leading issue motivating the United Kingdom to leave the EU, a fact that also highlights the risk of political contagion, and thus more capital disruptions. Much of Europe is struggling with the same immigration issues, on top of structural economic worries, that have cracked Schengen policies for the free flow of people and capital, and raised questions of the EU’s viability going forward.
Brexit could be the lead domino to fall in a wider political devolution for the Union. Or it could merely be an extension of the United Kingdom’s reserved approach to such intermingling of affairs — first demonstrated with their decision to keep the British pound in lieu of the new Euro.
What’s next for investors?
Either way, world financial markets are reeling from a surprise upheaval to the established order. Should the fallout persist and investors turn more pessimistic, the European Central Bank and U.S. Federal Reserve will face new challenges to an already unprecedented central bank regime.
Indeed, economic frustrations of stagnation that monetary policies have been unable to allay seem to be finding their release in reformative political policy. With historically lofty market valuations and a growing list of ever more consequential economic and political concerns, especially Brexit, investors should consider such worst case risks as more plausible when making decisions.
More of those risks are exposed under Brexit than at any time since the world financial crises of 2008 and markets will reflect this fact with alarming losses on Friday.