THE EFFECTS OF THE BREXIT ON FINANCIAL MARKETS 28

The Effectsof the Brexit on Financial Markets

The Effectsof the Brexit on Financial Markets

  1. Exchange Rate

The exchange rate is the first aspect of financial markets that isimpacted by a rise in market volatility when an economic blockexperiences internal disturbances. The ripple effect spreads rapidlyto all other currencies trading in the exchange markets this was thecase with Brexit, which is too much financial, was abrupt andshocking. As such, odds-makers and markets made the immediate swiftand rather a violent reaction is owing to this shock. Consequently,the pound hit a low against the U. S. dollar in many decades since1985, exchanging at $1.33 and slashing off 10% from the value of thecurrency. Similarly, the euro to hit a low against the dollar, sameto Japanese Yen and Chinese Yuan as these economies reacted to theBrexit vote. The graph below shows how the pound had been exchangingat the market against the dollar until the Brexit vote

  1. Changes in Stock Markets

Assets are traded at the stock markets, and their prices andvaluation, as well as volume, gives the clearest picture of how themarket is reacting to an imbalance in any of the economic blocks inthe global marketplace. As such, a study of how the stock marketswere before and after the Brexit vote should quantify the magnitudeof the economic impact of this referendum and more so on its outcome.

Before

Equity market operated because it was not obvious there was anexpected result that would change much of the value of businesses inthe markets. As such, the rates of exchange were what they had beenfor quite some time, same with asset value.

However, it should be noted that some stock markets indices wereoptimistic that Britons would vote to remain within EU and as such,rallied ahead of the referendum. Their hope applied specifically toFTSE 100, which adjusted positively on the bet that Britain was goingto remain within the union. Otherwise, other areas of the stockmarkets did not expect anything much and so traded normally.

The graphic below shows how the major stock market reacted to beforethe British vote

to leave EU

After

Some changes, rapid and violent, occurred throughout equity marketsin Europe. The effects of such changes trickled to all other stockmarkets across the entire globe. Some reorganization of the capitalmarkets that are worth noting included:

Flight to safety from the Eurozone or the epicenter of the exit ofBritain from the European Union as investors moved their shares fromthe region for safe-haven stock markets, mostly in the US and Japan.This was a reaction to higher interest rates on returns that wereevident as a consequence of the Brexit vote and was essentially goingto impact on the value of assets. Also, some investors opted forlower interest rate investments within the region. Evidence for thislaying in the values of both FTSE 100 and FTSE 250 before and afterthe referendum. FTSE 100, for instance, was valued at 6338.10 on theday of the referendum only to slump to a value lower than this.However, with assurances from the governor of the Bank of England,the index for some of London`s biggest listed companies recovered injust a few days following Brexit vote, and by the end of thisrecovery, FTSE 100 stood at 6556. A reaction by most investors toinvest in gold, leading to rising in the price of this asset seen bymost as safe-haven during times of trouble which in turn, bolsteredthe mining industry.

More affected was FTSE 250, which deals mostly with domestic andsmaller firms. For these, the index slumped by a 7% on the day of theoutcome of the referendum announced, from a high 17,334 to a small16,130. This sudden change attributed to the fact that most assets inthose small firms tend to be vulnerable to price volatility leadingto the flight to safe havens. Most investors took it as a precautionto move to investing in other more stable assets such as governmenttreasuries and strong and valuable assets such as gold. It isprobably why FTSE 250 took longer to recover from the shock and evennow, it is yet to stabilize.

Graphical illustration of how stock market reacted after theBrexit

  1. Inflation

Inflation is a consequence of market volatility and uncertaintyregarding economic troubles. Inflation also came out as a result ofBrexit vote and many economies around the world. As dollars and eurosstrengthened against the sterling pound, prices of products increasein the local British market as well elsewhere as the ripple effectspread. For instance, visitors or rather tourists to the UK had tospend more to get services due to a weaker pound that translated intoinflation in the local market. In a global scale, while the weakeningpound made exports from the UK to be competitive, it was for a factthat imports turned out to be much expensive and this resulted in anegative balance of payments. It was this ripple effects that madesome investors shift to the US and Japan where they saw as safehavens (Ekkers,Cretoiu, Kielak &amp Elsas, 2012). For the US, themanufacturing industry put to pressure by the strengthening dollar asthis meant they earned little from exports. As a result, a possiblemitigation would be to sell locally at a higher price, leading toinflation. Japan, on the other hand, is already struggling withdeflation from a weakening Yen. As such, Japanese Yen was likely tocontinue weakening as the global market trends implicated exports.China, whose primary export markets are the US and Europe, was tornbetween choosing to lower exports or import more or to practicehoarding as the global market recovers for the referendum outcomeshock. Either way, the result was an uncontrollable increase inprices of goods and services in an already fragile global economy.

Below graph summarizes the entire trend of Brexit effect duringthe whole period of referendum

  1. Tax Policy

UK adopted a pro-business fiscal policy in which the country aimed tolower tax cuts for corporate tax so that it may create an incentivefor investors to continue doing business in the region besidespreading a wave of fear of inflation following its exit from EU. Brexit created an avenue upon which the UK could free move on adifferent direction regarding the taxation policy both at thedomestic level and the international scale. Brexit created anopportunity where the UK designed better tax system which is moreopen to the investment and growth of new business. It is through thiskind of system which will enable UK to use her tax regime asshield against foreign competition which in turn leading to moregrowth in the economic sector as well as more job creation to theBritons (Richard, 2016)

From the table, above even though Brexit will throw the level ofbusiness and UK economy in the deeper negative territory. The taxpolicy which encourages the two to develop positive growthstowards attaining the positive sign on both the grow in UK economy as well as level of business confidence since most people will feelmore secure since they don`t face any stiff foreign competition

  1. Changes in Beta monthly and daily

Brexitreferendum created a lot of concerns, in particular for the financialmarket. As noted by most markets trends, any slight movement canquickly affect high yield for bond and bills in an economy. Taking anexample of Brexit as a factor, the change instantly makes it harderfor the government to finance their deficit, force them to lowertheir equity so as to boost the market confidence. Additionally,Brexit lead the pound to decline which in turn created mix reactionon both rises in yield and fall of the equities. It is the kind oftrend movement that has made most of the British asset to be lessattractive. As noted by the Bloomberg poll of economist out 24 of 34agreed that pound had declined below by $1.35 on the other side. Theother group pointed out that indeed there was Pound rise above $1.40would have an overall impact on the performance of the UK bonds andbill trading in the major stock market across the world. This mixreaction which made the like of John Wyn-Evans, head of investmentstrategy to conclude that Brexit indeed created a lot of negativeimpact for the sterling since most investors now fear the most liquid UK financial asset. The fear generated by this trend automaticallypressure more of the UK budget as well as the current accountdeficit this will again hurt the currency hence further downgradesthe British asset, a factor which in fact not only hurt the UKeconomies but also affect the international trade.

Below graphical table represent how the trend upon which both theBeta monthly and daily took

  1. Asset Pricing

In the wake of the referendum fears and worries spread amonginvestors in the UK and the entire Europe. Most investors out ofinvestment in shares for much safer investments, especiallygovernment bonds. As a result, assets whose main investment area isshares such as is the case with banks and house builders experienceda decrease in trade in them as investors moved their investment topurchase government bonds in the UK and elsewhere. Thus, there was ageneral increase in demand for government bonds, which in returnincreased gilts (yields in UK bonds). On the other hand, the yieldswhose movement is inverse to prices of government bonds, hit theirlow, apparently closing at 0.778% in the aftermath of the referendum.This result was almost half of its initial value that stood at 1.376%as of June 23, 2016 (Kristoufek,2013).

Apart from the shift in demands for bonds at the expense of shares,it was observed that the index had significant support from thosecompanies whose shares reported high earnings in the dollars fromtheir shares. This change in demand was a consequence of a fallingsterling pound against the dollar as observed under exchange ratesection. More specifically, a weakening sterling meant that itsearnings were equally getting flattered and so capital flight to theUnited States regarding asset investment was a clear outcome ofBrexit vote. Below is a graph which represented the trend in Assetpricing in the wake of Brexit

  1. Stock market return and interest rates

After castingtheir votes in June referendum, what most voters concern were theirworries on their money. People had a fear of how the Brexit withimpact on their mortgages, their pension as well as the way otherinvestment will either rise or fall. Most Britons were anxious aboutwhat will happen to the value of their currency and their holidayoversea. According to AA after the Brexit, the bill on the familyrose by close to 500 Pounds years, the overall cost of the billssoars further. Besides the sterling pound also collapse by 20% afactor which in turn made the stock market to slide by close to 30%(Teresa, 2016).

From thebelow graph, basing on that UK stock market is mainly dominated bylarge Multinational Corporation whose performance linked to thedomestic issue of UK Brexit being one of them. Markets usually don`tfavor uncertainty especially when there is real risk around

them.

  1. China’s fiscal policy changes as a result of Brexit

A notable event which happened after the Brexit referendum was the UKstands on her relationship with Asian countries and the Europeancountries. The UK noted she is the only country whose door is widelyopen for other trading patterns China inclusive. However, therelationship between these two nations withered off. The former UKPrime Minister Cameron stated that European China booster would haveto resign. This kind of policy means that Beijing will lose herstrategic access to Europe. Therefore, through Brexit, the overallglobal financial market of China will decline. As Bloomberg puts it,after the historic Friday vote in the UK, several countries had toabsorb the shock wave. For example in China Yuan had to be propped several strenuous interventions to help it regain it`s worth sinceimmediately after the vote, Yuan felt to the lowest point against the dollar in more than five years (Minxin, 2016).

How Chinasfiscal policy changes as a result of Brexit graphical representation

  1. Federal Reserve meeting because of Brexit

To avoid anyrisk which comes along with the Britain decision to leave EU, Federalhad to meet to discuss the fiscal and economic future of the Europeancountries. With fear of raising interest rate after the July vote bythe British to leave the European Union (Kenourgios,Samitas, &amp Paltalidis, 2011). Federal had to set July meeting to help set policies which willcontribute to cab economic uncertainty triggered by the referendumvote in the UK. To deliberate on this, the Fed member believes thatcontinuing strength of the US especially in the job market, mean thatany rate increase was no longer needed. It calls the entire memberto come up with a solution on how to help keep their rates athistoric low as they monitor how the Brexit turns (Jana, 2016).

Besides inthe meeting, basing off what Federal use to gauge the liquidity of aneconomy which is gold, due to the Brexit, they have to come up withpolicies on how to improve on the gold inflow market to counter theuncertainty which is presented by the declining pound due to theBrexit. As Business Insider puts it, Brexit not only lifted thebullion but gold stock as well. The meeting makes gold to climb freshhigh of 10% early morning trade in Barrick Gold and close to over 8%in both the Yamana Gold and Newmont Mining (Frank)

Graphicalrepresentation of Federal reaction towards Brexit.

  1. The Biotech Anomaly

In the current society we are living in, there is a significantexpectation of many fast growing sectors which to a large extentdemand for more premiums. Recent information has shown that there ismore rush in the current weak growth which has proved to have higherdividend stocks. The dividend stocks as they are mostly known by manypeople in Europe and around the whole world are referred to as thebond proxies (Ekkerset al, 2012, p.1015). The bonds proxies are mostly usedin the capitulation sector by many investors who are crowded in mostbond markets which are owned and controlled by the central banks.

A graph of biotech anomaly in financial markets of EU

The above-discussed yield-starved investors have contributed a lot inthe sector of the financial market. They have contributed by bringingvarious narratives which have affected the entire area of thefinancial market at large especially in the current low-interestrates in the marketing environment. However, stocks in thisparticular context refer to the new bonds. As a result, we have seenthat these starved investors have got no any other choice which isleft to them other than being forced to accept the high volatilitywhich has occurred due to the return of the dividends (Legge&amp Durant, 2010, p.62). At the same time, it isevident that the equity investors who have been there because o theEuropean Union have to a large extent shied away. It is because thereis a high growth of the large stock which has existed due to highconcentration of the high-quality assets which have been madeavailable in the market.

A chart describing biotech anomaly in financial markets of EU

Particularly, there has been a significant influx of variousinvestors which have flowed in Britain. The movement of investors hasbeen caused by the bond which has existed due to the European Union(Wellesley etal, 2012, p.523). The investors have been available dueto investment opportunities which are available because of a riskierend which is accessible in the investment spectrum. However, in thisparticular case, biotech has proved to be the outstanding candidatefor those investments which to a large extent have contributed morein the financial markets.

As a result, it has been demonstrated that the exit of Britain fromthe European Union as currently known as Brexit has and willcontribute significantly to the weakening of biotech which previouslyhas been a major contributing factor to the financial markets.

  1. A Regime Change in Financial Markets

A financial market significant change has been experienced in the UKand the US due to the EU. Notably, UK and the US have been at theforefront of liberalization. From an intellectual point of view, wecan politically consider the two issues and say that the countrieshave spoken out loudly mostly against the status quo (Featherstone,2011, p.193). However, this action has proved thatthere is a significant exhaust about the current regime which hasexisted between the two countries and the European Union whichincludes Britain. Moreover, it is very true to say that whatever hasbeen happening in the financial markets among the two countriestowards EU is not coincidental. Note that they are the pioneers whohave been enjoying the benefits of financial markets in the wholeglobe (Wellesley,Dolk, Boyd, Greenlees, Haeusler, Nelen, &amp Mullaney, 2012).

A graph showing A Regime Change in Financial Markets in EU

There is an implication that there is the probability of the domesticpolitics overturning the international relations including the supernational coordination efforts which have existed because there is astrong relationship between the two countries and the European Union.Moreover, they have been Feds who have been on the look of the globaleconomy on the matters of how it has a link to the financial markets(Kenourgios,Samitas &amp Paltalidis, 2011, p.97). In thisparticular issue, it is imperative to note that the US Treasury hasput many efforts to rescue many countries within the European Unionnot forgetting to mention the funding from the World Bank. It meansthat the exit of Britain from the European Union will lead experienceadverse effects to its financial market which has been on support dueto the economic relationships which have been there due to the twocountries (Hunter, 2016)

A chart showing A Regime Change in Financial Markets in EU

Particularly, it has been noticed that financial markets have beenaffected because Britain is revolving against the global order on itsown. Many such situations on which a country exists from a particularunion have proved that it is not an inventive step to adopt(Goodhart,2011, p.236-140). From research, it is very clear thatonce a country retreats, the other countries will hence take the sameaction and this means that the whole union will be weakened ordemolished. However, the act of Britain exiting the European Unionwill mean that the advances on which the financial markets was totake will be adversely affected.

  1. Effect on the digital currencies

The European Union has significantly used the Bitcoin in most of itsfinancial markets. From the year 2009, it is very evident that theBitcoin has gone many steps ahead and accumulated a significant stockin spite of collecting currency. However, after the act ofdistinctive boom and bust, the prices of the Bitcoin haveappreciated. For example, the appreciation of Bitcoin can be comparedto the internet bubble (Plassaras,2013, p.377). It means that the phenomenon has posed asignificant experience due to the increase of the Bitcoin usage.

A graph of the effect of digital currencies on EU financialmarkets

In fact, adopting of the Bitcoin in EU has led to the combination oftwo key libertarian features which are significant in the financialmarkets. The fast one is that the coin has led to the anonymouspayment system by utilizing various technologies. To no doubt, thetechnology has assisted in instituting and maintaining adecentralized ledger which should not be owned by a particularcountry (Kristoufek,2013, p.3). However, the accounting constitutes allBitcoin transactions. The transactions are also referred to as ablock chain. Moreover, the second important factor of the Bitcoinwhich is important in global financial markets in the EU is that theBitcoin is a fiduciary type of a currency whereby its supply cannotbe controlled by one country or a state. It means that Britain willsuffer from these specified consequences of the significance ofBitcoin to the financial markets when it exits from the EuropeanUnion.

A chart representing the effect of digital currencies on EUfinancial markets

It is evident that the Bitcoin has captured the entire European Unionfinancial market. The Bitcoin is digital and it means that most ofits transactions are very safe and fast. Moreover, it is alsodisruptive and very smart on those countries which have adopted it.We can hence say that to a large extent the Bitcoin has helped a lotin a wide area about the financial markets (Streeck,2012, p.67). However, the more a country adopts it, themore it makes its financial markets to turn out to be lucrative. Forexample, those countries which took it from a long time ago hasproved to be very significant. Similarly, the Bitcoin has shown towork best under states unions. Also, it means that the fact thatBritain needs to exit from the European Union means that it is goingto affect the strength of the Bitcoin in the country. As a result,the financial markets in the country will be weakened (Featherstone,2011).

  1. Fiscal Policy

The UK decision to leave the EU has tremendously affected hereconomic judgments in the UK, and the EU economy as a whole. The Bankof England (BOE) out of lingering fear in a market move by cuttingdown bank rates to a historical low of 0.25per cent. Besides herdecision to commit to buying another 60 billion Pound gilt (UK bondyield) and addition 10 billion Pound UK corporate bonds was aimed atimproving the level of investor confidence towards economy even aftershe has left the EU. Though the Bank of England economic reaction hada bit of positive impact, one question which most economics scholarswere left wondering was whether this kind of response could replicatethe historic 2008 fiscal policy which was adopted by the UK when shewas facing a very different set of problems as it is currently.

Notable during any financial crisis, interest rate falls to all-timelow, this, in turn, exposes a lot of too much debt since low-interestrate encourages both household and corporate to service their debtand also to prevent and the wave of default. BOE decision to cut downthe rates was to set help to avert any greater damages especially tothe banking fraternity as well as to the UK economy. Though duringBrexit debt was the only problem since majority had voted to the UKto leave EU, one of the greatest concern is slow economic growth.This concern was so since if compared to the 2008 policy response,the kind of challenge UK is facing is entirely different hence thiswill require a new set of policy guideline to address the issues.Below is a graphical representation of how Brexit has influenced thefiscal policy applied by BOE (Camilla, Canocchi&amp Lambert, 2016).

From the graph above much as the bank decision to lower interest rateled to decline in growth of the economy as seen in the last sectionof the chart. The decline was temporary since after the UK entirelyleave the EU, investor confidence will be enhanced thus, in turn,making the economy to look healthy again hence creating positivegrowth.

In conclusion, BREXIT is the step taken by the Britain Government towithdraw from European Union. The action came along with severalfinancial effects. Some of the effects include fiscal policy, regimechange in financial markets, biotech anomaly, effect on digitalcurrency, China fiscal policy among others. Nonetheless, the effectsare both positive and negative.

References

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