This memo, by the way, is reproduced with the permission of Brunswick Group.

EU Referendum: what comes next?

24 June 2016

Overview

The UK’s vote to leave the EU will have a profound impact on politics, business and the economy.

The Prime Minister has announced he will resign, his potential successors are preparing to kick start campaigns, while the markets try to make sense of what took place overnight.

But in the short and medium term what is likely to happen?

Brunswick’s Public Affairs team examines the issues:

• Britain is a country divided, not just along traditional party lines, but on life experience – particularly in terms of age, income and education. This not only has an impact on how domestic politics will evolve over the coming weeks and months, but this movement against the establishment will be closely analysed by pollsters in the US and across the globe as similar trends develop elsewhere.

• Leadership battle (1): - Boris Johnson is the firm favourite to succeed David Cameron as Prime Minister when he steps down in the Autumn although he does not always command the sort of support in the party as he does in the country The Tory party at Westminster will choose two candidates and then the party membership will decide the winner in a ballot, to be announced at their party conference in Birmingham in October. The others in the running could include Theresa May, Stephen Crabb and key Leave campaigners Andrea Leadsom, Priti Patel and Liam Fox. Chancellor George Osborne is now a 20-1 outsider, having been a hot favourite only 12 months ago.

• Leadership battle (2): The Labour party, meanwhile, also faces a potential leadership election, with moderate MPs tabling today a motion of no confidence against the party’s left-wing leader, Jeremy Corbyn, who is accused of having contributed to the outcome of the referendum through his lukewarm public support for the Remain campaign. But even if a leadership election takes place, Corbyn remains popular with most party members and so he (or another left-wing alternative) might be the most likely victor.

• Legislative pipeline: A Remain vote would have meant a return to parliamentary business on Monday with a re-start of this Tory government’s programme. This is now not the case. Parliamentary business will remain stagnant. Many policies will remain on the drawing board or at best the launch pad for example, on big decisions such as airport expansion.

• Another referendum on Scottish independence is possible. Nicola Sturgeon, First Minister of Scotland, has said Scotland has chosen to stay in the EU and that the option of a second referendum on Scottish independence is now ‘on the table’ and could be held in the period before the UK leaves the EU

Markets

• After an extraordinary first hour of trading, markets are showing some early signs of stabilising. By 10am BST, 2.2bn shares had traded in the FTSE 100, 538pc more than the average of 343m shares that have been traded by the same time over the past five days. European markets are trading even lower.

• The FTSE 100 has recovered slightly to a loss of 3.6pc by 2pm BST. Activity remains intense, particularly among the banks, house builders, estate agents and holiday companies. Most have felt compelled to issue statements to the market to sure up investor confidence.

• Interestingly, both the Frankfurt and Paris markets are markedly lower than the FTSE, which is being interpreted in a number of ways. One explanation is that they don’t have the release valve of sterling’s fall to cushion the blow. Another is that this is worse for some other European countries – Ireland, for example. And also possibly that European investors were not as prepared for the leave vote as their British counterparts.

• Sterling is effectively a self-correcting protection mechanism for the country, which has helped the UK weather the aftermath of the global financial crisis better than many other Eurozone countries and it is doing its job today by easing monetary conditions.

• The Bank of England will, at least for now, be content that its offer of support appears to have put a floor on sterling markets.

• The extent to which market weakness carries on will depend on whether investors see the unfolding economic impact on UK GDP as greater than the currently expected 2-3%, drop dependent for example on the exit terms for the UK.

Media

• Although media attention has focused largely on reaction from policymakers and the financial markets, there is significant interest in the position of corporates – with the most common questions being about the likely impact of Brexit on their business; the contingency plans they have in place; and whether they should have behaved differently during the campaign.
• Many companies are looking to strike a balance. They want to provide reassurance to employees, investors and other stakeholders but do not want to engage in the wider, febrile political debate. One option being pursued by several UK and international companies is to issue a reassuring internal message to employees to let them know that it is business as usual, which they also make available to journalists when asked for comment.

• Over the weekend, we can expect the media debate to move to a post-mortem of the campaign. In particular, journalists will be asking who is to blame for the defeat of Remain. The finger is likely to be pointed at Prime Minister David Cameron for calling the referendum in the first place; Labour leader Jeremy Corbyn for being lukewarm in his public support for Remain; and the strategy of Britain Stronger in Europe, the official cross-party Remain campaign, with its alleged focus on ‘experts’ and ‘Project Fear’.

Managing the divorce

• David Cameron has made clear that he does not want negotiations with Britain’s European partners on Brexit to begin straight away. Instead, he has said that he wants to wait for his successor as Prime Minister – likely to be in place by October – to trigger the ‘Article 50’ process under which an EU member state can begin the up to two-year process of deciding the terms on which the UK can withdraw from the EU.
• That raises the prospect of whether a new Prime Minister could seek to hold a general election in order to win a fresh mandate from the British people before he/she begins negotiations. Under Britain’s Fixed Term Parliaments Act, it is difficult – but not impossible – to engineer fresh elections before May 2020. If a vote does take place, the outcome could be deeply uncertain as a divided Conservative party battles an unpopular Labour party under its left-wing leader Jeremy Corbyn.
• But Brussels is adamant that the leave process is not going to be up to Britain. They will want this process over far quicker than UK politicians in order to avoid the UK exit deal becoming an issue in forthcoming elections in several major European countries.
• There will be concern over potential domino effect across Europe. Britain is not the most eurosceptic of the member states. Greece and France both record higher euroscepticism ratings, and Germany and Spain are consistent with the UK. It will therefore be important to look to the Spanish general election this weekend, as well as the French and German elections next year to see whether any of this sentiment comes through in Britain’s European neighbours.

• The big question for many people is how Britain manages its trading relationships with the rest of the world as the UK will no longer be part of EU trading arrangements when it leaves. We should not also underestimate the legislative challenge faced by Parliament to deal with all those areas of national life that have previously been governed by European Union legislation.

About Brunswick Group
Brunswick is an advisory firm specializing in critical issues and corporate relations. Founded in 1987, Brunswick is an organically grown, private partnership with 23 offices around the world.

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Turmoil in financial markets is the result of a referendum in the United Kingdom in which voters decided to leave the European Union, a decision that creates a great deal of uncertainty over what trade policy in the world’s fifth-largest economy will look like in the coming years.

What does seem certain, at least at the moment, is there won’t be any more Fed rate hikes this year. According to the CME Group’s reading of the fed funds futures markets, investors are betting that even by February of next year, rates will be where they are today: between 25 and 50 basis points above zero.

In fact, traders are assigning a 4.8% probability that the Fed lowers rates when it next meets on July 26-27, an opinion that stands in stark contrast to materials released after the Fed’s meeting earlier this month, when a majority of FOMC members predicted there would be two rate hikes by the end of the year.

Torsten Slok, chief international economist with Deutsche Bank Securities, says we won’t know exactly how the Fed is digesting this information until next month’s FOMC meeting. That gathering will not produce an updated dot-plot chart showing individual FOMC members’ predictions of the future path of interest rates.

But the bank’s statement should give us an idea of how it is balancing relatively strong labor market indicators--like historically low unemployment claims--with rising uncertainty over the state of the global economy.

Until that time, Slok argues that the futures market predicting no new rate increases this year is “a reasonable reaction.” We’ll just have to wait and see if the Fed catches up with market sentiment.

Fed officials not only have to worry about working to calm financial markets in the United States, but they also have to stand prepared to support markets around the globe. The dollars status as the global reserve currency means the Fed may need to provide emergency lending of dollars to foreign central banks, so that those banks can support financial institutions that need dollars to function.

The Fed committed to as much in a statement Friday morning:

The Federal Reserve is carefully monitoring developments in global financial markets, in cooperation with other central banks, following the results of the U.K. referendum on membership in the European Union. The Federal Reserve is prepared to provide dollar liquidity through its existing swap lines with central banks, as necessary, to address pressures in global funding markets, which could have adverse implications for the U.S. economy.

Big U.S.-based companies in the Standard & Poor's 500, including online advertising company Alphabet (GOOGL), software maker Microsoft (MSFT) and global bank JPMorgan Chase (JPM), suffered a collective loss in market value Friday of $657 billion, according to a USA Today analysis of data from S&P Global Market Intelligence. More than $160 billion in market value was erased from just the 30 stocks in the Dow Jones industrial average, says Howard Silverblatt, index strategist at S&P Dow Jones Indices.

The dramatic erasure of market value of big U.S. companies shows the double-edged nature of rising global commerce. Actions by a nation across the Atlantic can set off global asset repricing that costs U.S. investors serious money and reduces the value of U.S. companies.

Alphabet, the parent company of Google, was the company to suffer the biggest market value blow. The stock's 4.2% decline to $685.20 a share cut the company's market value by $20.4 billion in one day. Alphabet is still the second-most valuable company in the S&P 500 at $470 billion, but the company's 9% revenue exposure to the United Kingdom wasn't something investors were willing to pay up for Friday.

Tech's heavily global nature, and potential hit to earnings due to the strong U.S. dollar, showed up in the blow to Microsoft, too. The company saw its market value drop $16.3 billion as the stock dropped 4% to $49.83 a share.

While some other banks endured larger percentage drops in stock prices, the 6.9% drop to JPMorgan's stock price resulted in the biggest market value hit suffered by any financial to the tune of $16.3 billion. The bank got 15% of its revenue from Europe, the Middle East and Africa over the past 12 months.

Apple, the most valuable stock in the S&P 500 and Dow wasn't spared, either. The market of digital gadgets fell 2.8%, pushing the stock close to its low, and wiping out $14.8 billion in market value.

Looks like Britain's choice is taking money out of our pockets, too.

BIGGEST MARKET VALUE DESTRUCTION AT S&P 500 COMPANIES FRIDAY

Company, symbol, Market value change Friday (in $ billions)

Alphabet, GOOGL, -$20.4

Microsoft, MSFT, -$16.4

JPMorgan Chase, JPM, -$16.3

Berkshire Hathaway, BRKA, -$14.8

Apple, AAPL, -$14.8

General Electric, GE, -$12.6

Citigroup, C, -$12.2

Wells Fargo, WFC, -$11.2

Amazon.com, AMZN, -$10.9

Bank of America, BAC, -$10.7

Source: S&P Global Market Intelligence, USA TODAY

The pain on Monday was felt most by Europe’s wealthiest, where 92 billionaires lost $29.4 billion, bringing their two-day decline to $81.7 billion, data compiled by Bloomberg show. Since year-end, their net worth has slid more than $45.5 billion, a 5.1 percent decline.

The 150 billionaires from the U.S. and Canada lost $26.7 billion, or a two-day total of $62.5 billion. They’re essentially flat for the year, with a collective gain of $236 million. China’s 26 billionaires lost $1 billion Monday, bringing their two-day total loss to $5 billion. They’re down 7.4 percent this year, an $18.7 billion drop.

Germany’s third-richest person, Georg Schaeffler, fared the worst on the index Monday with $1.9 billion trimmed from his net worth. Europe’s richest person, Spanish retailer Amancio Ortega, shed $1.5 billion. Bill Gates and Mark Zuckerberg were the worst-performing U.S. billionaires on Monday losing $1.8 billion and $1.6 billion respectively.

There were 69 billionaires on the index who added to their fortunes Monday. Takemitsu Takizaki, the founder of Osaka-based Keyence, a maker of electronic sensors, led the gainers with an increase of $579.3 million. Japanese retailer Tadashi Yanai, chairman of Tokyo-based Fast Retailing Co., was behind him with a $552 million rise. Nineteen billionaires on the index added more than $100 million Monday.

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The cost of buying protection against a default on British sovereign debt using credit default swaps rose to a three-year high on Tuesday, after rating agencies rushed to slash the U.K.'s debt rating following last week's vote to leave the European Union (EU).

It now costs $48,500 a year to protect $10 million of U.K. sovereign debt for five years, compared with levels near $32,000 before the June 23 referendum, based on the mid-point of bid and ask spreads on Thomson Reuters. This came despite a sharp fall in yields on U.K. government debt, or gilts.

On its own, the absolute cost of insurance remains low, especially when compared with euro zone countries such as Italy and Spain.

The sharp pace of the increase, however, underscored how uncertainty over the U.K.'s position in Europe had undermined its credit-worthiness. Sterling has already plunged to more-than-30-year lows and stock markets have tumbled.

On Monday Standard & Poor's downgraded the U.K.'s debt rating by two notches, from AAA to AA, citing last week's referendum that approved a British exit from the European Union, depriving the U.K. of its last triple A rating. Fitch Ratings, meanwhile, moved its rating from AA+ to AA.

"In our opinion, this outcome is a seminal event, and will lead to a less predictable, stable, and effective policy framework in the U.K. We have reassessed our view of the U.K.'s institutional assessment and now no longer consider it a strength in our assessment of the rating," S&P said in a news release.

Moody's Investors Service last week lowered the outlook on U.K.'s sovereign rating to negative from stable, while affirming its Aa1 rating.

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