Is the renewed Brexit angst valid?


Now that Britain has set a date to start its Brexit divorce proceedings with the European Union, market jitters are back..

The bottom line, global market strategists say, is that the bulk of the financial pain will be felt by go-it-alone Britain, as its new prime minister Theresa May has said the U.K. will start official proceedings to leave the E.U. by the end of March 2017.

May surprised investors when she said Britain's main Brexit priority is to have full control over its borders and immigration policy, rather than focus its efforts on economic matters, such as seeking a better deal related to freedom of movement within the E.U. and better access to the E.U.'s single market. (The E.U. insists on open borders as terms of membership.)

"This amounts to a big splash for Britain but small ripples for the rest of the world," says David Kelly, chief global strategist at JP Morgan Funds. "The U.K. has to figure out how to leave and what comes next. The first part isn't very difficult, but the second part is extremely difficult. Britain started the clock on negotiations and it is very much like you lit a fuse and the bomb goes off in two years."

Like most divorces, the fallout will likely be felt by both parties. Brexit, a complicated dismantling of a decades-old trade pact, is no different. The U.K.’s European trading partners will also feel the chill.How severe a hit Europe suffers will depend on how smooth or contentious the multi-year Brexit negotiations go and how quickly investors and impacted parties can gain clarity on what Britain’s economic future will look like..

"The greatest risk is to the United Kingdom," says Russ Koesterich, head of asset allocation for BlackRock’s Global Allocation Fund.

Since May started the Brexit clock ticking this past weekend, the biggest fallout has been in the U.K. currency, the pound, which has fallen to its lowest level versus the dollar since 1985 and below where it was in the initial aftermath of the Brexit vote in late June. U.K. economic data points have bucked the uncertainty and London's main stock index, the FTSE 100, climbed to a record high this week, helped in part by a weak pound which makes Britain's exporters more competitive. In fact, the pound's depreciation will help "cushion the economic impact" of Brexit, Jonathan Loynes of Capital Economics said in a report.

Still, Brexit concerns loom. Timothy Palmer, a portfolio manager at Nuveen Asset Management, ticks off some negatives: The UK will suffer from slower growth. It will need to renegotiate complex trade agreements, and the terms may not be as friendly as the old pacts. Its financial sector -- a current global powerhouse -- will be weakened in the long term. Its economy, which up to now has weathered the storm caused by the June 23 vote to leave the E.U., will also likely be hobbled by uncertainty and indecision on the part of consumers, CEOs and trading partners, as none of the players will know the rules of the game.

"The honeymoon enjoyed by Brexit advocates is likely coming to an end," says Palmer, though he doesn't see Brexit or the U.K.'s troubles rising to a "systemic" level that could cause broader global market or economic "disruptions."

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While Britain is at greatest economic risk, there are two ways all the unknowns surrounding Brexit could spill over and hurt the broader Eurozone economy, Koesterich argues.

"First, if uncertainty starts to undermine U.K. business and consumer confidence, that will hurt European companies that trade with the U.K.," says Koesterich. "Second, if the Brexit vote is seen as a precursor of more political instability (in Europe) ... that could hurt confidence and start to undermine the broader Eurozone economy."

Adds Daniel Seiver, chief economist at Reilly Financial Services in San Diego: "New trade barriers will almost certainly be put in place that will disrupt EU-British trade, causing losses on both sides."

Another negative is that few market watchers see the E.U. going out of its way to offer the U.K. a good deal once negotiations begin. The reason: The EU won't want to give any of the other current 28 nations in the bloc a template for an easy exit.

"The U.K. will be at a disadvantage," says Kelly. "The E.U. won't want to give the Brits too good a deal. They will want to make sure that Britain is a cautionary tale."

 

 


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