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    GSAM Connect 
    |
    June 24, 2016

    GSAM Connect | June 24, 2016

    June 24, 2016 | GSAM Connect

    Market Update: The European Union Referendum

    On June 23, UK voters elected to leave the European Union (EU). As a result, market volatility has increased sharply, risk assets have weakened and developed market government bonds have rallied. As of 6:30 a.m. in London:

    • The British pound had fallen to 1.35 versus the US dollar, its lowest level in more than 30 years.
    • Equity indices were down sharply, with Japan’s TOPIX down more than 7% and S&P 500 futures down more than 4.7%.
    • US 10-year bond yields had fallen more than 30 basis points to 1.44%, their lowest level since 2012.

    Below, we discuss our initial thoughts on the implications of the referendum. On Monday, we will host a live webcast which will provide a more in-depth look at key implications of the referendum, as well as an overview of broader market developments and a mid-year outlook.

    What happens next for the UK and EU?

    Following the vote, the UK government first is likely to invoke Article 50 of the Treaty on European Union, which provides for a two-year period for negotiating a country’s withdrawal from the EU. Article 50 has never been invoked, which raises significant uncertainty regarding the process for negotiating and securing EU approval for an exit agreement. There can be an extension of the two-year negotiation period but this would require unanimous approval by all remaining 27 member countries.

    Political parties opposed to elements of EU membership have seen political gains in many EU countries. In negotiations with the UK, the EU may look to avoid any move that could fuel anti-EU movements in other countries.

    What is the longer-term outlook?

    The EU is the UK’s largest trading partner, with about half of UK exports going to EU countries and exports to the EU accounting for about 13% of UK GDP in 2014 (Source: IMF). Many of those exports are services, including financial services and insurance, that previously benefited from access to EU markets without having to meet regulatory requirements at the individual country level. The UK also benefited from EU trade agreements with over 50 other economies, which may now require re-negotiation. We expect that a prolonged exit and negotiation process will create a significant drag on UK exports and overall economic growth and a smaller but material drag on EU growth.

    Thoughts from Our Portfolio Managers

    “We expect a period of prolonged uncertainty. The UK referendum could provide a boost to political parties in other EU countries that are opposed to EU principles, and EU negotiations with the UK are likely to be challenging as the EU will not want to be seen as rewarding the UK for choosing to exit. We also expect materially weaker growth in the UK. The economy is heavily dependent on trade and the UK will now need to determine the conditions of trade with the EU and other economies, as well as future arrangements with the large number of EU citizens living and working in the UK.”
    - Andrew Wilson, CEO of GSAM International for EMEA and Co-Head, Global Fixed Income and Liquidity Solutions

    “We expect near-term reactions to include a jump in volatility and increased risk premiums for equity and currency markets. The fundamental impacts on economies and businesses are likely to be felt over a longer period of time. The exit vote will also increase scrutiny around the solidity of the European Union.”
    - Suneil Mahindru, CIO of International Equity, and Lead Portfolio Manager for Global and International Equity Strategies

    “We are closely monitoring markets to gauge the extent of contagion given the referendum results and this weekend’s Spanish election. We are also monitoring the policy response. As the timeline on the UK departure from the EU becomes clearer, we believe that market volatility will abate – depending upon the amount of contagion.”
    - Neill Nuttall, Co-Chief Investment Officer, Global Portfolio Solutions

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