Four Things to Know About Brexit

“Brexit” refers to the United Kingdom’s decision to remove itself from the European Union (EU). The EU is an economic union between 28 members that allows for free trade and unencumbered movement of labor. In other words, there are no tariffs on goods, and people in the 28 countries are free to live and work wherever they want.  The United Kingdom has been a member of the union since 1993 when the EU officially began.

What’s at stake?

Leaving the EU without a comparable economic agreement in place raises all kinds of questions about how the economy will be impacted. There are currently about 12,000 EU regulations that apply to the United Kingdom*.  These regulations are part of the reason that British citizens voted to leave the EU in the summer of 2016, but ripping up the current agreement without a suitable replacement raises big concerns for regulators and businesses.

There is a tendency to shrug off concerns for an isolated economy several thousand miles away, but keep in mind, the United Kingdom (and London specifically) is a financial hub.  With 500 million consumers**, Europe is a major contributor to global trade. Any disruption to the region would have ripple effects on financial markets. When “Brexit” was initially approved in June 2016, the S&P 500 briefly fell 5.5% and gold rallied roughly 8% over the following week. US markets will care about the outcome.

What’s the worst-case scenario?

A “Brexit” without an additional trade deal would likely lead to lengthy border delays for UK imports and exports, including tariffs on goods entering the country.  Economic growth would slow for the United Kingdom and likely surprise financial markets causing a sharp sell-off.  London’s status as a financial hub for Europe would likely erode over time.

The “Worst Case” scenario for the United Kingdom may actually become a net positive for the long-term viability of the European Union. If Brexit is a total train-wreck, other European countries would likely witness the fallout from leaving the EU and stay put, which would likely keep the rest of Europe relatively stable over the long haul.

What’s the best-case scenario?

A new agreement is reached with the remaining 27 countries to establish a new trade deal replicating the current one.  The UK then re-negotiates trade deals on its own with the rest of the world.  This is still incredibly time consuming and adds a great deal of uncertainty, but we would likely avoid a downturn in financial markets.

The downside, however, is that a smooth Brexit may incentivize other countries to try the same strategy. A “Frexit” or “Italexit” or “Spexit” would likely lead to even more uncertainty and chaos for the region.

What’s likely to happen?

Goldman Sachs has done extensive research on the possible outcomes and puts the odds of a worst-case scenario (a Brexit with no replacement deal) at only 15%. We have no way of knowing what a comparable deal may look like, or the potential fallout from the terms. Either way, uncertainty and change is rarely welcome in financial markets. The fallout from Brexit will likely be remembered as “noise” to financial markets.

*Per BBC News “EU rules into UK law: How's that going?” Sebastien Ash. BBC Political Research Unit. October 19, 2018.

**Per European Commission

Any opinions are those of Brady Raanes and not necessarily those of RJFS or Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Inclusion of the index is for illustrative purposes only. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary. Past performance does not guarantee future results. International investing involves special risks, including currency fluctuations, different financial accounting standards, and possible political and economic volatility. Commodities trading is generally considered speculative because of the significant potential for investment loss. The price of gold has been subject to dramatic price movements over short periods of time and may be affected by elements such as currency devaluations or revaluations, economic conditions within an individual country, trade imbalances, or trade or currency restrictions between countries.