What ‘Brexit’ means for markets

Sep 27, 2016

Though it seems the “Brexit” storm has blown over, uncertainty is likely to rear as the UK formulates its strategy to
exit the European Union (EU).

Following the surprise “leave” vote in June, the United Kingdom was quick to name a new prime minister, Theresa May, bringing relief to investors worried about a prolonged political limbo. And after an initial pounding, global stock markets hit fresh highs. Still, we expect the negotiation of the UK’s divorce terms will be long and complicated, with a few important ramifications:

UK recession risk

We expect a significant slowdown in the UK economy, and perhaps a recession. We expect the government’s focus to center mostly on Brexit negotiations, with little likelihood of a large fiscal stimulus program. The Bank of England responded with additional monetary policy support in August by cutting interest rates from 0.5% to 0.25% and restarting asset purchases.

Economic policy uncertainty, 2000-2016

Economic policy uncertainty, 2000–2016

Different direction for EU

Worries that the Brexit could trigger a breakup of the EU have subsided, for now. The political and financial market turmoil following the UK referendum seemed to jolt the rest of the EU out of a complacency.

Public opinion polls in July pointed to a rise in support for mainstream parties — and a corresponding drop in support for populist and extremist parties. Other polls point to a rise in public support for the EU. This appears to be true in Germany and the Netherlands as well as Finland and Austria.

European leaders are maintaining their position that they will not negotiate with the United Kingdom until Article 50 of the Lisbon Treaty (the prerequisite for entering exit negotiations with the EU) is triggered. They are no doubt eager, however, to capture the spoils from any exodus of financial services firms from London.

European slowdown

Uncertainty is likely to act as a drag on European growth. We see limited direct economic impact on the U.S., developed Asia and emerging markets (EMs), though downside risks are increased now.

The EU’s future, ultimately, hinges on if and how its leaders will address thorny issues, such as the tension between national and EU policies. This was the focus of the Brexit campaign, and it looms over Italy’s potential banking crisis.

Indeed, the post-Brexit selloff in financials highlighted Italy’s banking woes. Years of economic stagnation have led to a large pile of sour loans in the eurozone’s fourth-largest economy. Rome wants to rescue the banks with public money, but the eurozone has toughened rules on when public funds can be used to bail out banks. It remains to be seen if Italy can find a way to shield individual bondholders from losses.

Revised investment views

One thing that’s certain in a post-Brexit world: uncertainty. We see heightened political uncertainty, more modest global growth and low-for-longer interest rates ahead. The BlackRock Investment Institute has updated its asset views in accordance with this outlook.

Total Emerging Markets Fund
Invests across emerging markets equity, debt and alternative strategies with the goal of providing returns similar to those of emerging markets equities but with less risk.

We have downgraded European stocks to underweight, with a negative view of the eurozone banking sector. A preference for income leads us to upgrade U.S. credit and EM debt to overweight. We like U.S. investment-grade credit, hard currency EM debt, stocks in selected EMs and global quality and dividend growth stocks.

Overall, in today’s uncertain, low-growth environment, we prefer credit to equity and believe exposure to gold and alternatives as portfolio diversifiers makes sense.


Jean Boivin
Managing Director
Jean Boivin, PhD, Managing Director, is Head of Economic and Markets Research at the BlackRock Investment Institute, a global platform that leverages ...