I recently returned to the U.K., the land of my birth, for a visit. The purpose of the trip was primarily to see my family, but I did connect with some old market colleagues while I was there, and noticed that whoever I was with and whatever the conversation, one word cropped up almost every time: Brexit.
It didn’t seem to matter whether I was talking to family about possible vacation plans or to traders and brokers about the state of the markets -- every statement was qualified with a phrase along the lines of "...but what with Brexit and all..."
The level of fear and concern that surrounds the rapidly approaching deadline for the U.K. to leave the European Union surprised me. Living in the U.S. as I now do, I was aware that the whole situation was a mess, but from here it seems to be low down on everyone’s list of things to worry about.
Slowing internal growth, the trade war with China, North Korea, and even Venezuela -- these issues are all causing more concern here than what is going on on the other side of the Atlantic. That is a mistake.
The U.K. is a relatively small nation, but its economic fortunes have an outsized influence on the rest of the world, including the U.S., for a couple of reasons.
The first is that Great Britain is and always has been a trading nation. Total trade between it and America is close to $110 billion. That is nowhere near as significant as the $635 billion of trade with China, but still important. Even more significant is the fact that trade between the U.K and the EU in 2017 was around $615 billion. That is the number that will be hit hardest after Brexit, and the consequences will be felt across Europe.
That matters to American investors because this country’s total trade with the EU is even more than with China, at just under $718 billion.
The second reason that problems in the U.K. tend to have an outsized effect on the U.S. is that London has historically been one of the major financial centers of the world. In some areas, insurance and forex spring to mind, the London markets are often even more important than their U.S. counterparts.
If Brexit does cause as major a disruption to the U.K. economy as people there seem to be convinced it will, the ripple effect from the weakening of the financial system will be felt far and wide.
Remember, in the past, problems in some Asian countries, in Argentina and in Russia, have all prompted a reaction in U.S. stocks. It is naïve to believe that a hit to the U.K. and E.U. economies will somehow be contained to the other side of the pond.
Yet as the evidence mounts that there will be a disruptive end to the Brexit saga or, maybe worse still, it will be dragging on for much longer than anticipated, the U.S. stock market bounced back strongly yesterday.
The domestic market’s ability to do that suggests that even if the mess continues, traders will stay focused on other things for a while. If there is a decent deal with China, say, or if it becomes clear that last month’s terrible jobs numbers were just a fluke, we could see a period of strength in stocks.
For now, the markets are moving on the chances of a resolution to a problem with the $635 billion trading relationship with China and ignoring the potential for devastation to the combined $828 billion of trade with Britain and the E.U.
Eventually though, the Brexit chicken will come home to roost and when it does the effects could be much worse than U.S. investors seem to currently realize.