Financial markets around the world were rocked Friday morning after the U.K. voted to leave the European Union. The decision by voters in the U.K. to leave, known as Brexit, comes at a tenuous time for the global economy. Economic growth around the globe is slowing or stagnating in some regions. Some economists and investors worry that Brexit could reduce global growth further or possibly send some regions, particularly in Europe, into recession.
The referendum in the U.K. was close with the Leave option earning 51.9% of the vote. The Remain option received 48.1% of the vote. A breakdown of the vote by region in the U.K. can be seen in figure 1, where England and Wales voted to leave, and Northern Ireland and Scotland voted to Remain.
There were many immediate and significant reactions to the vote such as the resignation of U.K. Prime Minister Cameron, a drop in the GBP/USD of about 10% at its worst levels, significant losses in stocks across Europe, the U.K., and U.S., and political posturing in other regions across Europe. But what remains to be determined is the long-term impact of Brexit. There’s not much precedent for an event like this and it’s going to take a long time, probably years, for the U.K. to transition away from the European Union. With that timeline in mind, let’s take a look at the reactions across some of the markets in the U.S. and add some context to Friday’s sharp moves.
Financial Markets React to Brexit
Investors generally responded to Brexit vote by selling risk assets like stocks and buying defensive, or safe-have assets, such as Treasuries and gold.
The S&P 500 (SPX) opened lower Friday morning by about 3%, near the 2,050 level. And although Friday’s opening drop was sharp, it’s important to observe that the SPX was near its all-time high of 2,135 as of the close Thursday, ahead of the vote. Two support levels to monitor in the SPX in the days ahead include 2,050 and the 200-day simple moving average near 2,021 as seen in figure 2.
One interesting level to watch in the days and weeks ahead is 26.24 in the CBOE Market Volatility Index (VIX). This was the high of the VIX in pre-market trading Friday morning and also near highs seen earlier this year.
The VIX, also known as the “fear gauge,” is a measure of implied volatility in a strip of SPX options. VIX tends to move higher when stocks move lower, and vice versa.
What’s interesting about the VIX Friday morning is that it pulled back significantly from its high of 26.24 as seen in figure 3. Think of it this way: maximum fear according to the VIX, following the Brexit vote, was at 26.24. If at some point the VIX exceeds this high in the days or weeks to come, then it could be a sign that there’s more fallout from Brexit. Conversely, if the VIX stays below 26.24, and continues to fall, then it could be a sign that markets have discounted the Brexit news.
Another market that might be interesting to monitor in the days and weeks ahead is the 10-year Treasury Note Yield (TNX). The TNX is an index that tracks the yield of 10-year Treasury Notes. The TNX moves inverse to the price of Notes. So, if investors are rotating into the relative safety of Treasuries and driving the price of Notes higher, the TNX moves lower.
Government bonds around the world, like the 10-year Note, have generally been trending higher and yields trending lower. You can see this trend in the TNX in figure 4. Bonds have been moving higher, and yields moving lower, because investors have been worried about slowing global growth and central banks, like the Fed here in the U.S., have generally kept interest rates historically low. The Brexit vote Friday will likely extend these trends.
But interestingly, the TNX held above its low reached just last week at 1.518%, which was close to a low reached earlier this year. Like the VIX at 26.24, if the TNX were to fall below 1.518%, it could be a sign that investors are growing more fearful. However, if the TNX remains above 1.518% and moves higher, it could be a sign that investor fear is easing.
Like government bonds such as U.S. Treasuries, gold was a beneficiary of the news Friday morning. The front-month AUG 16 gold futures (/GC) rallied by about 5% to a new 52-week high, reaching as high as $1,335.90 as seen in figure 5.
Gold tends to be a beneficiary during periods when investor fear increases or worries over the global economy surface. There are generally two drivers behind this phenomenon.
First, some investors perceive gold as a store of value and safe-haven asset. These investors sometimes buy gold during periods of economic distress or heightened risk. Second, some investors might conclude that central banks could respond to the Brexit vote by adding more monetary stimulus. This stimulus can lead to currency devaluation and, eventually, inflation. Some investors view gold as a hedge against inflation. To this point, in the immediate aftermath of Brexit, the Bank of England said it was “well prepared” and ready to provide an additional 250 billion pounds in liquidity.
One last market I want to take a look at is the currency market. There was an historic move in the GBP/USD like I mentioned earlier. And the U.S. dollar saw extreme volatility Thursday night and into Friday morning. But it might be worth turning some attention to the EUR/USD.
One of the risks that some economists are talking about following Brexit is for other countries to follow the lead of the U.K. and exit the European Union. But at this point, with so many moving parts to the Brexit story, and lack of historical precedent for this type of event, it’s impossible to say how likely a domino-effect might be for the European Union. This is why watching the EUR/USD might be a way to eliminate some of the noise and speculation and focus on what the markets are telling us.
For over one year, the EUR/USD has been stuck in a tight trading range between about $1.05 and $1.15 as seen in figure 6. The news Friday pressured the pair to the midpoint of its range near $1.10, before rebounding a bit. If the EUR/USD breaks from this range in the coming weeks or months, it could be telling. For instance, a break above $1.15 could be a sign of stabilization in the European Union. Conversely, a break below $1.05 could be a sign that the European Union is at risk of further destabilization.
Stay Tuned for More News and Analysis of Brexit
Now that you have a little more long-term context in key markets relating to the Brexit news, make sure to stay tuned to Ticker Tape for more coverage of this story.
The best way to stay plugged in to the Brexit story is by following JJ Kinahan.
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