Brexit Breakdown: What’s The Likely Impact? by [email protected]

The surprising vote by the U.K. to leave the European Union — a decision dubbed the Brexit — has caused the pound sterling to plunge to a 30-year low against the U.S. dollar and stock indices around the globe to swoon, as the specter of uncertainty made investors run for the hills. The decision to leave the European Union also cost Prime Minister David Cameron his job.

The Dow Jones Industrial Average was down 3.4% to 17,400, the S&P 500 mirrored the decline while the Nasdaq was down more steeply, falling by 4.1%. Gold hit a 2-year high while oil futures fell. In Europe, the FTSE 100 in London lost 3.2%, France’s CAC was off 8% and Germany’s DAX index closed the day down 6.8%. Bigger selloffs were seen in Italy’s FTSE MIB and Spain’s IBEX — each down more than 12%. In Asia, Japan’s Nikkei 225 index fell 7.9% and Hong Kong’s Hang Seng index was off 2.9%. The euro was down 2.5% versus the dollar. U.S. government bonds soared and the yield on the 10-year Treasury fell to as low as 1.4% — a near historic level.

Wharton finance professor Jeremy Siegel said the markets responded as expected in the face of this U.K. development, which most politicians and brokers betting on the outcome didn’t foresee. However, he is certain about how the Fed will react. These developments are “totally taking out any expectation of a rate increase this year,” he said, adding that “the January futures on the fed funds rate is trading exactly where it is today.”

Wharton finance professor Joao Gomes agrees that the Fed will take a breather. “On the U.S. side, the response will surely be to delay interest rate hikes and perhaps a few reassuring statements that make it clear to investors that there is a safe haven and any downside risk can be limited.”

Indeed, Siegel believes the current blood bath in the markets will be short-lived. “My opinion is we’re going to get a lot of reversals … powerful reversals of this,” he said on Wharton Business Radio’s “Behind the Markets” show that airs on SiriusXM channel 111. He pointed out that the FTSE is still trading above where it was a week ago and the market, in dollar terms, is down only 3% compared to 7% to 9% for other regional markets in Europe.

The Brexit vote is “totally taking out any expectation of a rate increase this year.”–Jeremy Siegel

Moreover, “there was no panic. There was a lot of liquidity in these markets. In all of the major markets, it was a very active opening but we didn’t have many disruptions. They were liquid,” he said. “That’s saying an awful lot for a huge, major reversal.” Siegel added that U.S. stock futures were down 700 points but the markets opened normally and have rallied off the lows.

Gomes adds that while “this is the kind of additional uncertainty and volatility that will dampen short-term growth prospects” over the longer term, the Brexit’s impact should be contained. “Once the dust settles, the effect is unlikely to be large,” he says. “Europe has not grown significantly since 2008 and it will not grow significantly again next year. We are already used to that scenario and to this permanent-crisis mode.”

Impact on U.S., U.K and EU

Scheherazade Rehman, director of the European Union Research Center at The George Washington University, said Brexit is “what we call a ‘black swan’ event in Washington, D.C. We didn’t see it coming.” How will it affect the U.S.? Beyond volatility in the markets, “we really have lost our champion for free trade, globalization and eyes and ears on the ground with regard to security and other concerns at the EU table now – since they will not be sitting at closed door meetings anymore,” she said on Wharton Business Radio’s [email protected] Show on SiriusXM channel 111.

As for the U.K., Rehman said its economy will take a hit. “It will become more expensive for them to trade with the EU,” she said. The EU will tell the U.K. that “you still have access to the common market but you have to pay for that. You have to pay more than you pay now, except now you have no decision-making power.” However, Brian Klaas, a fellow at the London School of Economics, said on “Behind the Markets” that the EU can only punish the U.K. to a certain extent. “If they punish Britain too much, they will also suffer” since it constitutes 6% of the European economy. But if they don’t punish enough, others might leave.

The U.K. will try to retain existing trade and investment arrangements with the EU, but the bloc will not make it easy. “We will see initially at least a very tough stance from Brussels regarding the negotiations with the U.K.,” Gomes adds. Indeed, Olivier Chatain, a professor at HEC Paris and a senior fellow at Wharton’s Mack Institute for Innovation Management, believes the EU – France and Germany in particular – will want to make an example of the U.K. to deter other exits, he said on the [email protected] Show.

Many questions remain about the terms of exit and how negotiations between the U.K and the EU might proceed. On Friday, the Financial Times reported on an article in a German newspaper claiming that it had a copy of Germany’s “post-Brexit-referendum strategy.” The report says the U.K should not be treated leniently in exit talks because doing so might encourage other countries to follow. Handelsblatt reported, according to the Times, that there would be “‘no automatic access to single market’ because other states, including France, Austria, Finland, Hungary and the Netherlands, might seek similar deals. ‘The extent of such imitation effects would depend largely on how Great Britain was being treated.’”

“There was no panic. There was a lot of liquidity in these markets. In all of the major markets, it was a very active opening but we didn’t have many disruptions.”–Jeremy Siegel

But the fear that there could be a dash for the door could be overblown. Siegel said EU nations that have adopted the euro as their currency are less likely to leave the union. “No one wants to give up the euro,” he said. “That’s the difference from what’s happening in the U.K.” For an EU country using euros to change its currency “is an order of magnitude more difficult and less popular” than the Brexit. Take Greece. Despite its financial woes, the Greeks won’t ditch the euro to go back to the drachma and face devaluation. If Greece won’t leave, it’s unlikely others will, he said.

Eventually, Gomes expects an agreement to emerge between post-Brexit U.K. and the EU. “After some mutual recriminations, which could last some time, everyone in Brussels and London [will work toward a rapprochement because both have] a strong vested interest in making this relationship work,” he says. “That basically means working out a new treaty that preserves as much of the meaningful economic ties as possible while reassuring the British people that immigration can be controlled.”

It would be ironic, however, if the EU used its clout over negotiations to push the U.K. to adopt

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