Sizing up the Brexit Risk

On June 23, voters in the United Kingdom will decide in a referendum whether to remain in the European Union. And while it looks like the “stay” camp might edge out the “leave” camp, the polls show a statistical dead heat.

If I were a betting man, I’d wager on cooler heads prevailing and the Brits opting to stay put. That’s what the actual betting markets are pricing in, anyway.

But what if they don’t?


After all, a year ago no one would have bet on Donald Trump becoming the presumptive nominee of the Republican Party, or on Bernie Sanders giving Hillary Clinton a run for her money.

But these days, anything’s possible. Voters are angry and agitating for change. And for what it’s worth, Trump, who’s never shy about offering an opinion, recently encouraged British voters to leave the EU.

Not that British voters necessarily care, mind you. But it goes to show that anti-establishment voices around the world share similar sentiments.

And yet, this British exit – or “Brexit,” as they’re calling it – is hardly getting any press on this side of the Atlantic.

Domino Effect

It should. It’s a big deal in my opinion. A really big deal.

Even if the UK were to split from the EU, London would probably maintain its role as the financial capital of Europe. None of the other financial centers are big enough or sophisticated enough to carry the torch.

But beyond that, it gets murky.

If the British leave the EU, then Scotland will probably vote to leave the United Kingdom, in my view.

That, in turn, may embolden Catalonia and possibly the Basque Country to finally pull the trigger and secede from Spain.

And once you have a euro-denominated country like that go through a political breakup, yields on European government bonds would probably spike all across the continent.


German Dilemma

It would basically be a continuation of the Greek sovereign debt crisis… maybe on a larger scale.

At that point, would Germany be willing to prop up the Eurozone? Or would German voters shout nein, walk away, and allow the entire Eurozone experiment to go up in flames?

Again… no one really knows. Which is precisely what makes all of this so disturbing.

But even if the UK votes to stay put, the very fact that they’re having a referendum is proof enough of how fragile Europe is right now.

Ever since the sovereign debt crisis started six years ago, European integration has been going into reverse. Banks have essentially been walled in under the control of national regulators.

There’s been plenty of talk of restricting migration between EU member countries. And overall, the European world is getting smaller rather than larger.

Divided US

On our side of the Atlantic, it’s not too different. The presumptive nominees of both political parties are two of the most polarizing political figures of the past 30 years. There is literal talk of building a wall… as well as figurative walls by re-negotiating trade deals.

The overall trend across the entire Western world is one of disengagement and retrenchment.

I think that’s bad for economic growth… and by proxy, the stock market.

Market Impact

Let’s get back to the case at hand, the potential Brexit on June 23. Again, I see cooler heads prevailing. But if they don’t, I think we should expect the following to happen:

  1. The U.S. dollar should soar in value relative to the euro and the pound. Markets hate uncertainty, so they will stick with the perceived stability of the dollar.
  2. U.S. bond yields (and probably German yields) will likely hit new all-time lows. I would expect British and most other European bond yields to spike, bringing on another 2010-style debt crisis.
  3. Energy prices will sell off again, putting pressure on the U.S. banking system and the junk bond market.
  4. Stock markets, particularly in Europe, will take a major hit. Investors will sell first and ask questions later.

Again, I don’t expect the Brits to take that jump into the wild unknown. But as we get closer to June 23, you’ll want to keep an eye on this.

Because, if there is any single thing that could take a wrecking ball to your portfolio, I think this is it.
This article first appeared on Economy & Markets.

Photo Credit: brett jordan via Flickr Creative Commons