Markets experienced significant turbulence after a surprise referendum result leading to the departure of the United Kingdom from the European Union. The S&P volatility index approached year-to-date highs, with the banking sector getting hit hard by the subsequent sell-off. JPMorgan Chase & Co. (JPM:NYSE) closed down -6.95% on Friday to $59.60 following the initial shock of the vote. After Monday’s reopening, shares continued to tumble, sliding another -3.34% to $57.61.
While there is no doubt that the Brexit result is a problem for bank stocks in the short-term, it will not actually materially change the short-term structure of companies with operations in the UK. In a letter to clients, JPMorgan CEO Jamie Dimon said, “the framework of the UK’s engagement with the EU, including trade agreements, will be negotiated over a period of years. For the moment, we will continue to serve our clients as usual, and our operating model in the UK remains the same.â€
Macroeconomic Give and Take
There is little doubt from economists that the UK decision to leave the EU will have an adverse economic effect. Imposing barriers to trade will likely further restrict a world economy growing at just 3.10% and reduce growth in the Euro Area, which has already imposed negative rates in an effort to stimulate anemic economic growth.Both the British Pound and the Euro, two of the most important currencies in the world, weakened against the dollar immediately after the referendum. A rising US dollar makes American goods more expensive to export, which is contractionary for the economy.
However, impending world economic uncertainty drastically reduces the likelihood of the Federal Reserve raising interest rates. Higher interest rates are contractionary, so delaying a rate hike, and even potentially cutting rates, may even out currency moves.The day after the Brexit vote, even the tiniest likelihood of an interest rate hike got pushed back to December of this year, but most likely the Fed will hold off until 2017. The Implied odds from futures pricing showed the probability of an interest rate cut running from 0.00% to as high as 14.00% in November in an effort to stimulate the US economy.
